Tue, 8 May 2012
The increasing power of PBM's like Express Scripts is putting pressure on drugstores, according to Morningstar's Matt Coffina.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. The Wall Street Journal recently named six Morningstar equity analysts Best on the Street. I'm here with Matt Coffina. He was named one of the top drug and food retail analysts. We're going to talk about some of the trends facing the sector in 2012 and his top picks.
Matt, thanks for joining me today.
Matt Coffina: Thanks for having me, Jeremy.
Glaser: So, first off, what are some of the major trends that are going to be affecting the drug retailers throughout this next year?
Coffina: So the two big issues affecting this space are really--at least in the near term--are the mergers that have happened: Express Scripts buying Medco, the two largest pharmacy benefit managers or two of the three largest getting together to form a new PBM that will be 50% larger than their next largest competitor. Also, we heard in an announcement that SXC Health Solutions plans to buy Catalyst Health Solutions, which are two smaller PBMs in the industry, but that move still speaks the general trend of consolidation.
And then on the other hand, there's the dispute between Walgreen, which is the nation's largest pharmacy chain, and Express Scripts, again where Express Scripts basically excluded Walgreen from its pharmacy network.
Both of these trends will have a big impact on the drug supply chain and retail drugstores, in particular. Both of them you could say would be negative trends for the retail drugstores and positive for the PBMs, the companies that actually run the drug benefits.
Glaser: If you look at winners and losers there, with Walgreen losing Express Scripts, does that create an opportunity for other retailers? Or does this end up being pretty much a wash?
Coffina: No, it absolutely does [create opportunity]. Express Scripts accounted for about 12% of Walgreen's pharmaceutical sales, and Walgreen is losing about 85% of that business right away as of January. Those numbers for the most part are flowing to other pharmacy chains, and CVS Caremark has been the most visible beneficiary of that. So, patients are basically forced to leave Walgreen, and they end up going to CVS.
Glaser: With everything going on in this space seems like there are a lot of customers up for grabs. It seems a little bit fluid. What's happened with valuation levels? Are the stocks trading at attractive levels?
Coffina: We think most companies in this industry are about fairly valued. The one that stands out really is Express Scripts. It's trading for about [$18 lower than] our fair value estimate. Basically, we don't think that the market has given the company credit for the synergies it is likely to realize through the Medco acquisition and as a result, we think that investors that buy the stock at this level can capture most of those synergies.
Glaser: Do you have any other names that look attractive right now?
Coffina: Outside of the drugstore business, I do like WellPoint. I also cover the managed-care companies, and WellPoint looks particularly undervalued. It has about a 13% free cash flow yield trading for less than 9 times this year's earnings. So it's not a great growth story, but valuationwise we think the company is quite cheap.
Glaser: Well, Matt, congratulations and thanks for talking with me today.
Coffina: Thank you.
Glaser: For Morningstar, I am Jeremy Glaser.