Express Scripts

(ESRX)

has lost some of its strength.

The pharmacy benefit manager failed to move investors with its latest report of record quarterly results that once again beat Wall Street expectations. Fourth-quarter revenue climbed 18% to $4.6 billion, coming in $100 million ahead of the average forecast. Meanwhile, operating profits rocketed 45% to a record $195 million.

Excluding a special charge, Express Scripts posted fourth-quarter earnings of 77 cents a share that beat the consensus estimate by 2 pennies. But the company had delivered even larger upside surprises the previous two quarters.

It also issued 2006 guidance of $3.10 to $3.22 a share, including stock option expenses, that looks to be in line with the $3.15 consensus estimate.

Investors, clearly used to better, punished the stock in after-hours trading. The shares, which were on the rise earlier in the day, fell 2.9% to $91.18. But the company remained decidedly upbeat.

"We enjoyed an outstanding year in 2005," proclaimed CEO George Paz, "building a solid foundation for growth in 2006 and beyond."

Early Call

Last month, Wall Street Strategies analyst Brian Sozzi recommended buying Express Scripts in anticipation of fourth-quarter upside and strong chances for another banner year.

Sozzi cited Medicare opportunities and generic-drug utilization as drivers for the stock. For example, he pointed out,

AstraZeneca

(AZN) - Get Report

had just lost a patent case that could lead to generic versions of the company's blockbuster hypertension drug by the middle of this year. Importantly, he noted, Express Scripts and its two largest competitors --

Caremark Rx

(CMX)

and

Medco Health Solutions

(MHS)

-- include the medication on their national formularies, "creating yet another highly profitable generic drug opportunity" for the group.

PBMs can significantly mark up cheap generic drugs to boost their bottom lines.

When penning his Jan. 20 report, Sozzi noted that shares of Express Scripts had "picked up right where they left off" in 2005 -- when they more than doubled to lead the solid PBM group -- by adding nearly 6% in the first weeks of the new year. The stock was approaching Sozzi's $94 price target before the after-hours fall.

Still, Sozzi did mention some valuation concerns before the latest run-up. He specifically worried about a possible first-quarter miss -- and a resulting hit to the stock -- with analyst expectations already ahead of management's own guidance.

Sozzi listed three broader risks as well. He said that industry opportunities, particularly those involving the new Medicare Part D program, could "take a bit longer to bear fruit" than some have anticipated. He also said that government regulation -- already a reality in the state of Maine -- could threaten the PBM business model going forward. And finally, he mentioned the possibility of a government crackdown on Express Scripts in particular.

Express Scripts has come under scrutiny by New York Attorney General Eliot Spitzer. The other two major PBMs face government probes of their own.

The so-called Big Three have come under fire for allegedly saving their customers less money than they should. They have been accused of pocketing huge profits on generic drugs, with two of them -- Caremark and Medco -- being singled out this week for allegedly hiking prices on brand-name drugs sold to Medicare recipients as well.

The industry's powerful lobbying group, known as the Pharmaceutical Care Management Association, has insisted that PBMs are saving senior citizens money instead.

Three Strikes

On Tuesday, congressional Democrats released three new studies suggesting that drug prices have been rising rapidly under the new Medicare program.

The first report found that prices for popular brand-name drugs rose by more than 4% during the first seven weeks of the Part D program. The second found that those same drugs now cost 14% more under Part D plans than they did under the early Medicare discount cards that have come to be viewed as failures. And the final report found that the card providers negotiated "at best minimal discounts" from drug manufacturers in the first place.

The first report mentions Caremark and Medco by name.

Using a possible "bait-and-switch" tactic, it suggests, Caremark's Silverscript Plus Plan entered the Part D program with the cheapest overall prices for 10 highly popular brand-name drugs. But over the course of a few weeks, it says, the company had jacked up its prices by 10.2% -- more than any other plan -- for those same drugs. Moreover, it adds, the company raised its price for a popular anti-clotting medication by four times that amount.

The report offers a similar review of Medco. It says that Medco's YOURx Part D plan began by offering the second-lowest prices on popular brand-name drugs. But a month later, it finds, Medco's prices for those drugs had jumped by 7% -- with its price for a popular heartburn medication rocketing by a whopping 66%.

In contrast, the study shows, prices for the same drugs sold by

Drugstore.com

(DSCM)

-- an online retailer catering to the general public -- barely budged at all.

Throwing Swings

A second study found the Part D offerings even worse than the early discount cards shunned by most Medicare recipients.

For example, it claimed that cholesterol-lowering Zocor now costs 27% more under 10 popular Part D plans than it did under the discount cards. It reached a similar finding about a widely used reflux medication as well.

Moreover, the study portrayed the discount card program as a failure in its own right. Specifically, the study found that "the prices available to seniors using the drug cards were 75% higher than the prices negotiated by the federal government for the Department of Veterans Affairs, 72% higher than prices available to consumers in Canada and no better than prices already available to seniors at Costco stores or through Drugstore.com."

The third study found that the discount card providers had ultimately negotiated "minuscule" price cuts of just 3% to 5%.

The PBM trade group immediately came out swinging. The group criticized the first study in particular for alleged flaws in design.

"Regrettably," PCMA President Mark Merritt said, "this new study ignores two fundamental cost-savings options available to Medicare beneficiaries: mail-service pharmacies and generic drugs."

PCMA goes on to say that past studies have shown that mail-order pharmacies can reduce drug prices by an extra 10%. Moreover, it notes, substituting generics for brand-name drugs can result in even larger savings of up to 60%.

Interestingly, PBMs are banking heavily on mail orders and generic sales -- two especially lucrative business lines -- to help fuel their growth growing forward.