(MHS) Medco Analyst Maintains Shares at Neutral

Recently, we reiterated our Neutral recommendation on Medco Health (MHS) with a target price of $56.00.

During the third quarter of fiscal 2011, Medco reported adjusted EPS of $1.07, beating the Zacks Consensus Estimate by 2 cents and 12.6% higher than the year-ago quarter level.

Revenues increased 4.1% year over year to $17.0 billion in the quarter, in line with the Zacks Consensus Estimate. The increase in revenue was primarily driven by contributions from significant client wins coupled with higher prices charged for branded drugs, partially offset by higher volumes of lower-priced generic drugs.

In fiscal 2010, Medco’s top ten clients (based on revenues) contributed approximately 47% to net revenues. Its largest client, UnitedHealth (UNH) accounted for 17% of net revenues. However, in July 2011, Medco failed to renew its PBM contract with UnitedHealth despite arduous negotiations. The existing agreement is set to expire in December 2012.

The company also witnessed several other contract losses that include the Federal Employee Program (FEP) contract in May 2011, the Medicare Part D business of Universal American as well as the biggest US public pension fund California Public Employees’ Retirement System (CalPERS), all to CVS Caremark (CVS).

In August this year, Medco also lost its PBM contract with Blue Cross and Blue Shield. Despite undertaking various efforts, Medco was not able to successfully overcome these hindrances.

In July 2011, Medco announced that it would be acquired by Express Scripts (ESRX) for $29.1 billion in cash and stock. With the completion of the deal, Express Scripts Holding Company will be formed wherein 59% of the stake would lie with the shareholders of Express Scripts.

Although we expect the combined entity to pose a major challenge to its peersby becoming the largest PBM provider, we remain concerned about the uncertainty regarding the successful completion of the deal based on the potential anti-trust challenges from the Federal Trade Commission (FTC). Recently, FTC requested both Medco and Express Script to submit additional information regarding the pending acquisition deal. Although Medco expects to close the deal by the first half of 2012, the company will suffer a major blow if the situation turns around.

However, during the quarter, Medco witnessed higher service revenue growth fueled by United BioSource acquisition. In addition, under the specialty segment, Accredo’s performance remains strong primarily due to significant client additions and organic growth across the business.

CVS CAREMARK CP (CVS): Free Stock Analysis Report

EXPRESS SCRIPTS (ESRX): Free Stock Analysis Report

MEDCO HLTH SOL (MHS): Free Stock Analysis Report

UNITEDHEALTH GP (UNH): Free Stock Analysis Report

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