Stock Mart: Priority Healthcare

It took just one press release to chop Priority Healthcare's (PHCC) stock in half -- and it wasn't even about earnings.

Priority, which directly distributes high-end drugs and pharmacy supplies to customers nationwide, spiked to 48 3/4 on July 30, and it seemed to have more room to run. Its second-quarter earnings came in three cents higher than analysts' expectations on 60% year-over-year revenue growth, and momentum investors such as Jeff Vinik of Vinik Management were buying up large chunks of the stock. (As of June 30, Vinik owned 419,000 Priority shares, according to Technimetrics.)

But then Caremark, a subsidiary of MedPartners (MDM) and a competitor to Priority in the expanding pharmacy services industry, went on the offensive using what Kai-Teh Tao, a Watson Investment Advisors' portfolio manager, calls only half in jest the "best press release of all time." (Tao's firm owns 100,000 Priority shares.)

An Aug. 2 release said Caremark would become a preferred specialty pharmacy provider of Schering-Plough's (SGP) Rebetron, an in-house combination therapy for hepatitis C patients. The news shook out a lot of Priority's investors since the same therapy makes up 8% of Priority's sales and 20% of its profit margin. The Street figured Priority -- which already had its own Schering contract for the combination therapy -- would lose share in this rapidly expanding market.

"That was the negative catalyst we needed to get out of the stock," says Tom Bleakley, fund manager of the (NAGQX)Small-Cap and (NAMCX)Mini-Cap funds at Nicholas Applegate. Other money managers also followed and the stock slipped all the way to 23.

The catch, it seems, is that every specialty provider has a "preferred" designation to sell Schering's Rebetron, including Priority. "Anyone buying Schering has to sign this sort of contract with them," says Don Perfetto, Priority's chief financial officer. "The preferred priority was not a term Schering endorsed -- it just so happens we have also been buying this product from Schering for quite a long time."

Bob Consaldo, a Schering spokesman, says if any investor thought "preferred meant exclusive that would be a misinterpretation. We sell this product to a number of distributors." A Caremark spokeswoman declined to comment.

Priority's Perfetto says that in the last six to eight months that Caremark has been a competitor in the hepititis distribution field, Caremark hasn't made any inroads on the company's businesses. Priority's pharmacy services make up 25% of its total revenue and is its fastest growing unit. Oncology, physician services and dialysis make up the other three-quarters of Priority, which as a whole is expected to generate $410 million in revenue this year, up 49% from 1998.

Due to its recent slide, "Priority's gone from a mo-mo stock to a growth stock," says Watson's Tao. It could also be considered a bit of a value stock, Tao says. Priority's price-to-sales ratio is down to 1.5 from a high of 3.1, and it's on track to post annual earnings of 91 cents per share this year, and $1.25 a share in 2000, a 37% year-over-year earnings growth rate. Priority's price-to-earnings ratio based on the 2000 projection is 20, meaning it's undervalued compared with its expected growth rate.

Perfetto also says the company has a large opportunity to sell its products on -- surprise! -- the Internet. Through sites such as drkoop.com (KOOP) and the company's own hepatitisneighborhood.com, it can develop a community of Priority drug users.

"It's a clinically rich group of people where we can see how many are coming to buy from us," says Perfetto, who adds that it also accentuates its direct sales business, which allows it to have much higher revenue-per-employee rates than one of its main competitors, Accredo Health (ACDO). Priority's revenue-per-employee rate is $2.4 million over the past four quarters, while Accredo's is $905,000.

That kind of efficiency has value players jumping back into the Altamonte Springs, Fla.-based outfit. "I think this stock cratered at 22, 23, and that's why I'm buying it now," says one New York-based money manager who requested anonymity. The manager says the company is trading at a discount to Accredo, which is growing at "only" a 40% year-over-year revenue growth rate and sporting a trailing price-to-earnings ratio of 79. Priority's trailing P/E is 34.

The company also is getting support from within. It announced a 2 million share buyback Tuesday, and Thursday, boasts Perfetto, CEO Bob Myers bought 4,000 shares. There has been no recent insider selling by top managers.

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