FBR Capital Markets lowered its price target on shares of Medco Health Solutions Inc. (NYSE: MHS) by $4 to $71, while maintaining its outperform rating.
The brokerage said it maintained its rating despite the recent announcement of Medco losing $3 billion of annual revenue from Federal Employees Program (FEP) contract going to competitor CVS Caremark Corp. (NYSE: CVS).
In addition, we are removing our Top Pick designation for Medco Health Solutions shares, as the recent news does affect growth prospects for 2012. Even if Medco's management decided to get more aggressive on its pricing strategy for the current selling season, we would be concerned that such a dynamic could help create a more aggressive pricing environment, said Newton Juhng, an analyst at FBR Capital.
Juhng would view such an environment as a lose-lose scenario for all the major pharmacy benefit management (PBM) players in the long run.
Juhng said he has held Medco Health Solutions shares as his Top Pick for over eight months; but, with the recently announced loss of the FEP contract, it will be a considerable challenge for the company to make up the $3 billion of annual revenue and 9.8 million annual mail order prescriptions.
The company could make further price concessions related to winning percentage on other available contracts; but such practices would be more detrimental in the longer term for the company and the industry, says Juhng and adds that he does not expect Medco Health Solutions to take the drastic step of adopting a win at all costs mentality to pricing its services for up-for-bid contracts.
The brokerage lowered its 2012 EPS estimate for Medco Health Solutions by $0.33 to $4.72 and its revenue estimate by $3 billion to $70.10 billion.
We have lowered our 2012 revenue estimate by $3 billion to account for the lost FEP contract. As a result of the lost volume, at standard margins, we would have expected to lose $0.11 of earnings power from 2012. However, due to the fact that the volumes were mail order prescriptions, the impact of the lost volumes results in a more severe $0.33 impact to 2012 EPS estimates, or a 7 percent reduction in EPS. Our new EPS estimate is $4.72, representing 14 percent year-over-year growth, said Juhng.
Juhng does not believe investors should look at the company’s failure to retain the FEP contract as an indication that the UnitedHealth Group, Inc. (NYSE: UNH) contract is any more at risk than it was prior to last week’s announcement. Management maintains a strong relationship as a vendor to UNH.
While there can always be a change in emphasis by either party, Juhng expects there to be at least some level of relationship maintained by these two companies. His worst-case scenario would be for a portion of the UNH business to be moved in-house when the contract expires at the end of 2012.
Medco Health Solutions stock closed Friday's regular trading down 8.97 percent at $58.66 on the NYSE.