Medco Fans Checking the Mail

After a breathtaking rally, pharmacy benefit managers such as Medco (MHS) and Caremark (CMX) could face an unexpected hiccup.

In recent quarters, the giant PBMs have raced ahead on a slew of favorable industry trends. But now they could weather slowing growth in their most profitable business.

Goldman Sachs foresees looming pressure on PBM mail-order pharmacies that enjoy especially strong margins on the sale of generic drugs. The firm issued a cautious note on the group this week after surveying hundreds of employers about their planned health care benefits for 2006.

That survey, the firm says, shows that fully one-third of employers plan to let their workers obtain 90-day prescription refills at retail pharmacies instead of pushing them to use mail-order facilities operated by PBMs. Moreover, the firm notes, that shift comes at a time when patent expirations will make the generic opportunity especially strong.

"We suggest that investors monitor the number of 'mandatory mail' PBM agreements announced for 2006," wrote Goldman Sachs, which has a neutral outlook on the group. "At issue, in our opinion, is the growing competition to dispense generic prescriptions -- particularly as the volume of generics grows in 2006 -- in order to capture the significant operating profits" associated with those drugs.

For now, however, the PBM stocks continue to hold up well. Medco slipped 22 cents to $52.85 on Thursday, after a big jump a day earlier on a Merrill Lynch upgrade. Caremark fell 17 cents to $48.48, but even after announcing a $138 million fine involving a company it acquired, it continues to hover near its all-time high. And Express Scripts (ESRX), which shrugged off a Merrill downgrade on Wednesday, went on to climb 26 cents to $59.72 Thursday.

Prescription for Success

Merrill Lynch analyst Thomas Gallucci clearly highlighted the industry's most important business when upgrading Medco's shares.