5 Pharmacy Benefit Mgr (PBM) Stocks for a Healthcare Play
Alan Brochstein examines 5 PBMs as attractive value and growth plays
Healthcare hasn’t been exactly the friendliest sector for investors in the past few years. It turns out that not only is the sector vulnerable to the state of the economy, but also our demand for services exceeds our ability to pay as a society. With so much focus by the government on cost, there have been very few havens. As the saying goes, “if you aren’t part of the solution, you are part of the problem.”
The winners have been companies that can either improve outcomes at the same or lower price or ones who can take cost out of the system. One group that arguably does both well is the pharmacy benefit managers (PBMs).
Even if you aren’t familiar with the term “PBM”, you are probably a customer of one. These companies administer the pharmaceutical plans for the major insurance companies as well as directly for employers. The big ones are Express Scripts (ESRX), Medco (MHS) and CVS Caremark (CVS).
These companies create formularies (lists of drugs by category) and incentivize plan members to use “better” drugs – “better” usually meaning “cheaper for the same outcome”. The major tool on that front is to steer the patient towards a generic (non-branded) alternative, but it can also mean using one branded drug rather than another due to safety or efficacy. These companies are all about reducing the costs to the plan sponsor by changing behavior of the plan members.
Another effective cost-saving tool is to drive the purchase from the retail store to mail-order, which is more efficient and can also improve patient compliance in taking their drugs correctly. Mail-order and generics are two of many different tactics the PBMs employ.
As you can see in the charts below, the PBMs have had a nice run but have been pulling back lately:
Even the weakest of the names, CVS, has outperformed the S&P 500 over the past 5 years. ESRX has been the big winner so far of the “Big 3”, while MHS hasn’t done too badly either. Lately, though, MHS has been very weak, while Small-Cap Catalyst Health (CHSI), which is trading near 32.50 as I type, has been pounded on contract concerns.
Before I give a quick review of each of these companies, here is a table that gives fundamental performance for the stocks above, as well as some operational and valuation metrics:
Clearly the YTD performance for this group has been lackluster at best. Investors are somewhat concerned that the number of new generics next year will be lower than 2010. Lipitor comes off patent, but at the end of the year. The outlook beyond 2011, though, looks very strong to me. Additionally, there are some concerns regarding competition, with CVS expected to try to regain some lost market share.
Hitting the 5 names in order, CHSI, which is on my watchlist, has pulled back sharply lately (32.50 as I type). Investors are specifically concerned about the renewal of its largest client, Wellmark - although a loss, as improbable as it would seem, would reduce CHSI’s earnings by just 10% or so. On the flip-side, CHSI is highly differentiated from its larger competitors in terms of transparency and customer service. CHSI also just made a very exciting acquisition that should boost growth in 2012. Unlike the larger companies, I believe that CHSI isn’t as constrained on the revenue front due to its smaller size.
CVS entered the industry by purchasing Caremark a few years ago and really dropped the ball as it tried to offer customers an “integrated” approach that included physical stores. Competitor Walgreens (WAG) and CVS duked it out earlier this summer. WAG has a PBM as well, but it doesn’t try to force its clients to use its stores. CVS has lagged, but for good reason – it has lost customers. Still, I’d say it’s attractive at 10 P/E as they try to regain market share.
ESRX has had a stellar run after acquiring the PBM assets (and a long-term contract) of WellPoint (WLP). This company has clearly been the best PBM in terms of growth and customer retention. I would caution that momentum investors who look at historical growth may change their mind as things normalize given the full integration of that Wellpoint transaction.
MHS, which was spun out of Merck (MRK) several years ago, strikes me as extremely inexpensive. Unlike their peers, they are opening the doors internationally, offering potentially further growth down the road. I believe that they may not have as good of customer service historically as ESRX, but they appear to be the innovators in the industry.
Last but not least, SXC Health Solutions (SXCI) is a neat little company, part PBM and part technology company. Their margins are large, and their growth is robust. The only knock is the stock’s current valuation. Like CHSI, though, size works to their advantage.
I like the PBM industry for the long-term, as it is well-aligned with the current challenges of that our country faces in healthcare. Quite simply, they reduce cost and improve efficiency and quality of outcomes. For Small-Caps, CHSI strikes me as very attractive. For those more interested in larger companies, MHS looks like the value play, while ESRX, with its recent pullback, may appeal more to growth investors.
Disclosure: Alan Brochstein currently holds no positions in the companies mentioned above.
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