Predicted Gross Margin Pressure, EPS Erosion Turn Bernstein Bearish On Express Scripts

Shares of Express Scripts Holding Company ESRX have risen more than 30 percent since Thanksgiving 2017, mostly due to expectations of earnings improvements stemming from U.S. tax legislation. But the gains are now "overdone," according to Bernstein.

The Analyst

Bernstein's Lance Wilkes downgraded Express Scripts' stock rating from Market-Perform to Underperform with an unchanged $69 price target.

The Thesis

Express Scripts' recent momentum can be attributed to expectations for improved earnings due to tax changes, Wilkes said in the downgrade note. While the company could see a near-term earnings per share benefit of 21 percent due to changes in the tax structure, the EPS benefit will "erode" to just 10 percent by 2021, he said.

The overall pharmacy benefit manager space is seeing peak gross margins, Wilkes said. PBM gross margins are roughly split evenly from rebate retention; retail spread; and traditional mail order and specialty home delivery, he said. The retail spread and rebates are at risk looking forward, and client pricing pressure could reduce gross margins over a five-year period from 7.8 percent to 7.4 percent, the analyst said.

The policy environment has turned negative for PBMs and other companies within the drug supply chain, Wilkes said. The potential entry of Amazon.com, Inc. AMZN is a particularly negative event for Express Scripts due to the increase in competition, which could prompt the company to change its business model at the expense of gross margin, he said.