Medco Health Solutions Inc. (NYSE: MHS) is in a strange place The healthcare company is potentially the subject of more cost crunching, but someone supposed to be one of the best investments in its industry. The issue seems to concern the proper size of the company, rather than its valuations or growth potential.
The company’s operations are as a healthcare cost containment player and a prescription benefits manager. Cost-savings operations are derived in part from savings on drug prescription costs, thanks in large part to providing generic drugs that treat disease more cheaply than name brand drugs. The company’s compound annual growth rate by its own metrics has turned out to be north of +20% and the guidance is still +19% to +21% ahead. The other growth drivers outside of generics are Medicare, mail order, specialty operations from Accredo, and more. There have been some rumblings that its contract with UnitedHealth Group, Inc. (NYSE: UNH) may be at risk, although that contract still has close to three years on it and the promotion is nearly side-by-side.
Jim Cramer got a CEO interview after the guidance was raised here, where he called it the cheapest he’s ever seen a great growth stock. In that interview, the CEO noted that there are $105 billion in annualized sales of drugs coming off patent from the years 2010 to 2015. The CEO also stressed non-generic growth opportunities.
That doesn’t sound like things are very bad at all for Medco.
Also, if investors are so down on Medco, then why did it recently announce a deal to acquire United BioSource Corporation in an all-cash buyout that valued BioSource at close to $730 million? This deal gives Medco a source of post-approval drug and device research that expands the operations and capabilities in data analytics and research. Medco is also in the middle of a huge stock buyback and its UnitedHealth contract is not up until 2013.
One issue working against MHS could be the $19.5 billion market cap and the law of large numbers. At $45.13 its 52-week trading range is $44.21 to $66.94, so the stock is much closer to a low than a high for the ‘bargain buyers.’ With Thomson Reuters estimates of $3.38 EPS in 2010 and $3.95 EPS in 2011, the forward earnings multiples are 13.3 for 2010 and 11.4 for 2011. Revenues are expected to be $65.36 billion in 2010 and $69.4 billion in 2011, so this trades at roughly 0.3-times revenues.
S&P recently raised its debt rating on the company to “BBB+” from “BBB” based upon a financial policy consistent with a modest financial risk profile. S&P even noted that the US healthcare policy leaves their business model intact and the ratings agency further noted that yet another debt rating upgrade was likely in the next two years. Because of the business model being intact, S&P also raised rival Express Scripts Inc. (NASDAQ: ESRX).
The most recent analyst initiation was from Avondale, and Medco only scored a “Market Perform” rating around August 10. Shares were trading around $47 at the time. Thomson Reuters lists its mean price target average above $66.50 at the current time. While that seems very high, it implies 44% upside in the name.
All in all, Medco seems to be entering that maturing phase of its business cycle and that may bring a different sort of investor. There still seems to be room for Medco to offer both growth and value at the current time. $20 billion or less is not the peak value of a company, but continuing its growth of the past is likely going to be harder than easier ahead. That appears to be why its valuations are at historic lows.
As of this writing, Jon Ogg did not own a position in any of the stocks named here.
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