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Express Scripts Sinks

Shares tumble as revenue misses targets.

Express Scripts

(ESRX)

still looks fit.

The St. Louis-based pharmacy benefit manager on Tuesday beat Wall Street expectations for the third quarter and raised its guidance for the full year. Rising sales of generic drugs, many of them delivered through the company's lucrative mail-order pharmacy, fueled the record results.

Revenue climbed 13% to $4.33 billion during the third quarter but fell a bit shy of the $4.44 billion consensus estimate. Other metrics looked stronger, however. Net income jumped 13% to $115 million. Meanwhile, earnings per share of 83 cents beat the consensus estimate by a penny.

Looking ahead, Express Scripts now expects to post full-year profits of $3.16 to $3.28 a share -- slightly ahead of previous guidance.

"Our industry-leading generic utilization rate reached a record 58.3% by helping our clients take advantage of new generic drugs that entered the marketplace," boasted ExpressScripts CEO George Paz. "The more successful we are in helping clients and members save on prescription drugs, the better we perform."

Still, ExpressScripts weathered a slowdown in another lucrative business line. Notably, the company saw profits in its Specialty and Pharma Business Solutions division fall by nearly half in the latest quarter. Part of the downturn stemmed from a shift in patients to Medicare Part D plans, but some came from the midyear loss of a major third-party client as well.

Investors, nervous about industry challenges already, had clearly hoped for better. They pushed shares of ExpressScripts down 3% to $70.25 in after-hours trading.

Worrywarts

These days, PBM investors have more to worry about than usual.

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Last month,

Wal-Mart

(WMT) - Get Walmart Inc. Report

started selling hundreds of prescription drugs for just $4 apiece -- less than some customers have paid in the past when flashing their prescription drug cards. Some fear that Wal-Mart's program could expand and pressure high-margin generic sales at PBMs going forward

Meanwhile, more recently, critics of so-called average wholesale prices -- relied on by PBMs for the sale of brand-name drugs -- took a big step toward dismantling the entire AWP system. Critics call AWP "ain't what's paid" and insist that the system artificially inflates drug prices by billions of dollars each year. They have inked a legal settlement forcing First DataBank, the largest publisher of AWP numbers, to roll back prices on most brand-name drugs next year and stop publishing AWP lists altogether down the road.

Both developments have overshadowed current strengths boasted by PBM operators.

"Recent concerns surrounding Wal-Mart's $4 generic program and potential changes to the average wholesale price (AWP) benchmark pricing has increased uncertainty about the ability of PBMs to expand profitability," A.G. Edwards analyst Andrew Speller admitted in a research note last week. But "we don't believe that either Wal-Mart's generic program or a potential change to AWP pricing will negatively impact ESRX during 3Q06, 2006 or into 2007."

As more blockbuster drugs go generic, Speller sees the potential for pleasant surprises ahead.

"While PBMs begin to see some margin benefits right away, the major boost doesn't take place until at least six to 12 months after the products have entered the market," Spelling noted. "This implies that there may be additional margin upside from generics for ESRX as it enters 2007."

For now, Speller has a hold recommendation on ExpressScripts' stock. His firm makes a market in the company's securities.