(MHS) Medco Health Solutions 2011 Second Quarter Earnings Preview

Medco Health Solutions Inc. (MHS) is scheduled to release its second-quarter 2011 earnings on July 21, 2011 before the market opens. The company is expected to report EPS of 94 cents on revenues of $17.08 billion during the quarter, according to Zacks Consensus Estimates.

With respect to earnings surprises, Medco has exceeded the expectations in three out of the trailing four quarters. During the fourth quarter of fiscal 2010, the company reported in line results. The company has positive average earnings surprise of 2.70%.

Along with the first quarter results, Medco raised its guidance for fiscal 2011 based on solid growth across all its segments. The company expects to deliver adjusted EPS in the range of $4.02-$4.12 (previous range of $3.80-$3.93) representing growth of 13%–16%.

Previous Quarter Highlights

Medco reported an EPS of 80 cents during the first quarter of fiscal 2011, up 19.4% from the year-ago quarter level of 67 cents. After adjusting for amortization of intangible assets, the company’s EPS came in at 91 cents, beating the Zacks Consensus Estimate of 88 cents and 19.7% higher than the year-ago quarter’s 76 cents.

Medco reported revenues of $17.0 billion, up 4.3% year over year but marginally missing the Zacks Consensus Estimate of $17.1 billion. The increase in revenues was primarily driven by contributions from significant client wins as well as higher prices charged on branded drugs, partially offset by higher volumes of lower-priced generic drugs.

During the quarter, Medco witnessed a 57.5% year-over-year growth in service revenue to $357.8 million primarily attributable to the acquisition of United BioSource and growth in its client service offerings. Revenues from Medco’s specialty pharmacy segment, Accredo Health Group, increased 14.9% to $3.1 billion primarily due to significant client addition and organic growth across the business.

Agreement of Analysts

Analysts’ estimate revision trends are insignificant for the for the past one month. Over the last 30 days, 1 out of the 24 analysts covering the stock pulled down the estimates for the quarter ended June. Further, 1 analyst decreased the estimate over the last 7 days. None of the analysts made an upward revision over the last 30 days and 7 days. The same trend was noticed for fiscal 2011.

However, we notice a perfectly reversed trend for the third quarter, where 1 analyst out of 23 has increased the estimate in the 30 days and 1 has made a upward revision over the last 7 days.  The Zacks Consensus Estimate for the third quarter is pegged at $1.06 cents per share.

Concerns remain on the pending renewal of Medco’s lcontract with UnitedHealth (UNH).  This is significant as the largest pharmacy benefit management (PBM) represents the largest at Medco as well as successive contract losses in recent times. Under the current agreement with UnitedHealth, Medco will provide PBM services till December 2012. The company expects to initiate discussions regarding the renewal in the second half of 2011. Although Medco is confident about the renewal, the company will suffer a major blow if the situation turns around.  We expect further clarity from the company on this front.

Further, in May 2011, Medco lost its integrated PBM contract with Blue Cross and Blue Shield for the Government-wide Service Benefit Plan or Federal Employee Program (FEP) to CVS Caremark (CVS). This is a major set back for Medco as this contract generated nearly $3 billion in annual revenues (including approximately 9.8 million mail order prescriptions) or about 4.5% of the company’s total sales in 2010. Further, contribution of the contract to the company’s 2011 earnings guidance is around 10%.

Furthermore, with the acquisition of the Medicare Part D business of Universal American by CVS Caremark, the former’s contract with Medco was terminated, effective 2012.  We believe these contract losses will induce Medco to reduce its guidance for fiscal 2011. We also believe that the company will implement effective strategies to revive its PBM growth.

Magnitude of Estimate Revisions

The magnitude of revisions is insignificant over the past one month. Overall, estimates for the second quarter remained unchanged at 94 cents per share in the last 7 and 30 days. A similar trend can be seen for 2011, with estimates remaining at par with the current level of $4.10 per share.

Our Recommendation

Despite all the recent headwinds, we believe Medco is well positioned to capitalize on inherent sector tailwinds such as increasing prescription trends, a mix shift toward mail order distribution, the aging baby boomers population, and significant brand-name drug patent expirations over the next few years. The company is expected to witness higher service revenue growth on the back of United BioSource acquisition. In addition, under the specialty segment, Accredo’s performance is expected to remain strong primarily aided by significant client additions and organic growth across the business. The company has a strong balance sheet that augurs well for further acquisitions.

We currently have a Neutral recommendation on the stock, which corresponds to the Zacks #3 Rank (Hold).

CVS CAREMARK CP (CVS): Free Stock Analysis Report

MEDCO HLTH SOL (MHS): Free Stock Analysis Report

UNITEDHEALTH GP (UNH): Free Stock Analysis Report

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