Caremark Soothes Some Wounds

A nice quarter at the benefits manager lifts the stock.
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delivered another healthy quarter, offering some relief to investors hurt by a painful slide in the stock.

The giant pharmacy benefit manager topped both revenue and profit targets for the first quarter, even as more and more clients sought alternatives outside the traditional PBM industry. The so-called Big Three -- Caremark,




Express Scripts


-- have long been accused of saving their customers less money than they should, and have attracted widespread government scrutiny and lost some major contracts as a result.

The stocks have come under added pressure in recent days following disappointing guidance from Express Scripts and delays associated with a significant generic drug opportunity.

For now, however, Caremark continues to post strong operational results. The company saw first-quarter revenue climb 7% to $8.9 billion, beating the consensus estimate by $200 million. Net income jumped 16% to $229 million, while earnings per share of 51 cents topped Wall Street expectations by a penny.

In addition, Caremark issued new earnings guidance that remains in line with analyst forecasts despite lower near-term profit opportunities associated with generic Zocor. Looking ahead, Caremark expects to earn 54 cents or 55 cents a share in the second quarter, and between $2.29 and $2.35 for the full year. The consensus estimates for those two periods are 55 cents and $2.30, respectively.

Caremark's stock surged 5.2% to $46.95 on the positive update.

'Good Start'

Caremark CEO Mac Crawford declared the first quarter "a good start to the year," with the company enjoying growth in mail-service and retail pharmacy revenues alike.

Still, the company has posted stronger increases in the past. Notably, the company's high-margin mail business weathered a major sequential slowdown in both revenue and claims growth. Meanwhile, the company processed fewer retail pharmacy claims than it did a year ago due to previously disclosed contract terminations.

The company helped offset those losses, however, with new business from Medicare Part D -- a major opportunity that arrived just as the Big Three started losing some big contracts to competitors offering more transparent business models.

JPMorgan analyst Lisa Gill has embraced traditional PBMs, and Caremark in particular, all along. Indeed, she urged investors to act before the current earnings season.

"As there is generally a lack of meaningful intra-quarter data releases or news flow, quarterly earnings results are again likely to provide a near-term catalyst for the PBM group, which has traded down over the past few weeks despite no change to the fundamental outlook," Gill wrote last week. "We believe stock selection in the PBM segment will continue to be the key to out-performance and recommend Caremark and Medco as the two names to own in the group going into earnings."

JPMorgan counts all three major PBMs as clients.

Words of Caution

Gill has touted Caremark's stock -- and dismissed the company's problems -- on a fairly regular basis.

She has voiced some concern when analyzing Express Scripts, however. That caution recently proved well-placed, with highflying Express Scripts falling back to Earth over the past week.

"The company conservatively affirmed 2006 earnings guidance," explained Prudential analyst David Shove, "indicating investor expectations may have caught up with the accelerating earnings."

The pain only worsened on Monday, when a federal court issued a ruling that could severely limit the number of companies that can sell generic Zocor for the first six months after the branded drug's patent expires. PBMs have been counting on multiple suppliers to roll out generic versions of the drug immediately, driving down prices -- and driving up their own profits -- in the process. Now, however, the companies will probably have to wait until next year before they start pocketing those outsized gains.

Of the Big Three, analysts agree, Express Scripts has the most at stake. The company has made a big push to shift customers toward Zocor ahead of the generic launches.

"Express Scripts has reaffirmed its 2006 EPS guidance in light of the news," noted A.G. Edwards analyst Andrew Speller, who has a hold recommendation on the sector overall. "However, we believe that the company may have difficulty reaching the top end of its guidance" if the court's decision is upheld.

Medco, banking on a similar boost, took a hit on the ruling as well.

Labor Pains

Of course, Medco has its own headaches.

Notably, the company has wound up in a high-profile fight with the union that represents hundreds of its employees, and it could lose some unionized clients as a result. In late March, the company locked 500 workers out of its mail-order pharmacy in Las Vegas during a stand-off over health care benefits. The company has been using temporary workers as replacements, union officials say, and risking patient lives in the process.

"The union has received reports from members who have not been locked out that the temporary workers have mishandled temperature-sensitive pharmaceuticals such as insulin," the United Steelworkers announced in a recent flurry of press releases last week. And "Medco has even told its call centers to expect delays in prescription deliveries from its Las Vegas mail-order pharmacy."

Medco itself has pledged to continue operations without any disruptions in the services that it provides to its customers. To be sure, the company understands just how important prompt service can be. Notably, the company lost a huge federal contract for allegedly failing to meet contract deadlines in the past.

Now, the union has threatened Medco with the possible loss of other business as well.

"Medco stands to lose a large chunk of its business if it doesn't end this illegal lockout soon," insisted union President Leo Gerard. "We have heard from many of its union clients that they will look for other prescription plan providers if the illegal lockout continues."

Medco's stock peaked at $60.64 on the very day that the company announced the lockout in Las Vegas. It has lost 15% of its value in the six weeks since that time. It did regain some ground on Tuesday, however, bouncing 1.1% to $51.57 on Caremark's favorable results.