Medco Beats, Provides Strong Outlook

Medco Health Solutions (MHS) reported third quarter earnings of 75 cents per share, well above the Zacks Consensus Estimate of 71 cents as well as 63 cents reported in the year-ago period. Medco, the largest pharmacy benefit manager (PBM) recorded an increase of 17.8% in revenues which came in at $14.8 billion primarily driven by contributions from significant new client wins, as well as price inflation on brand-name drugs, partially offset by higher volumes of lower-priced generic drugs.
 
Revenues from MHS’ specialty pharmacy segment, Accredo Health Group increased 19.2% to $2.4 billion primarily due to significant addition of new clients and organic growth. 

The reported quarter has been quite significant for Medco. The huge acceptance of generic drugs (they have higher margins for PBMs compared to branded drugs) is evident from the fact that the generic dispensing rate increased 3.3% year over year to a record 67.7%. In addition, both the mail-order and retail generic dispensing rates increased 230 basis points to 58.1% and 300 basis points to 69.4%, respectively. 

Medco records more than 50% of its revenues from retail products. For the third quarter, out of $14.59 billion of net product revenues, retail products accounted for $9 billion with mail-order products accounting for the rest. Both retail and mail order products recorded an increase of 29.9% and 2.3%, respectively compared to the same period last year. Increased retail product sales have brought down the gross margin to 6.1% from 6.5% in the comparable period while the more profitable mail-order volume dropped by 2.3%. 

At the end of the third quarter, Medco had $2 billion of cash balance after paying down $400 million of short term debt. Cash flow from operating activities increased considerably during the period – $2.5 billion compared to $797.2 million in the third quarter of 2008. 

Based on the robust performance of all the segments, Medco raised its 2009 earnings guidance. The company revised its earnings guidance to $2.80 - $2.82 per share (earlier guidance: $2.76-$2.81), an increase of 20-21% compared to the year ago period. 

In addition, Medco announced its outlook for 2010. The company expects earnings per share in the range of $3.28-$3.38, an increase of 16-21% compared to the new guidance for 2009. We believe a strong balance sheet along with significant new client wins in addition to retention of existing clients enabled the company to present a robust outlook for 2010.

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