Where is the Dividend Express Scripts?
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Admittedly I've written about this before, but previously these two companies were separate entities. However, the new Express Scripts Holding Company (NASDAQ: ESRX) now represents the combination of the previous Express Scripts and Medco. What's amazing is, before these two companies combined, each one generated significant free cash flow, and was expected to show earnings growth in the low to mid-teens. The combined company shows even better characteristics, with earnings growth now expected in the high teens, and free cash flow that is more than 30% higher. With better earnings growth, and better free cash flow, the argument needs to be made again that Express Scripts should institute a dividend immediately.
For investors who aren't aware, in the pharmacy benefit management category there are now essentially two major players. The first is Express Scripts, which is the combination of two of the larger players previously. The second is CVS Caremark (NYSE: CVS), which operates the well-known CVS drugstore chain, but also Caremark which handled nearly 200 million pharmacy claims in the last three months. While each company represents an attractive investment option, the big difference is only CVS pays a dividend whereas Express Scripts does not. The growth in prescription drug use seems to be unending and both CVS and Express Scripts should continue to benefit from this trend. With analysts calling for earnings growth of 13% from CVS and over 18% growth at Express Scripts, it's clear that the prescription benefits business will see significant growth in the next few years. In Express Scripts recent earnings report, investors can clearly see the huge difference that the merger of Express Scripts and Medco created.
Nearly every number in Express Scripts earnings report showed significant improvement versus the prior year. However, each of these results has to be taken with a grain of salt considering the company did not compare organic growth versus growth that occurred from the merger. The company's adjusted claims were up 118% and EBITDA increased 132%. Express Scripts also showed a retention rate for its business of 95%.
One of the biggest pieces of news, was the company's new multi-year pharmacy network agreement with Walgreen (NYSE: WAG). This gives Express Scripts access again to the thousands of Walgreen locations that they did not have access to in the beginning of the year. This was a big win for Walgreen, given the difference the company saw in their comparable sales without this agreement in place. Prior to the loss of Express Scripts business, Walgreen saw comparable sales increase 5.3% at the end of last year. In the January through March timeframe, the company saw comparable sales down at least 6%. This decrease was primarily due to the departure of millions of Express Scripts customers. This new agreement should be a win-win as Walgreen will once again be able to offer Express Scripts benefits to their customers. Express Scripts benefits as they will have thousands of additional distribution points through the Walgreen pharmacy network.
With this issue resolved, analysts see over 18% earnings growth from Express Scripts in the next few years. Significant growth and cash generation is the reason I believe the company should institute a dividend to reward its shareholders. Looking at the company's financials, let's figure out what type of dividend Express Scripts could afford.
In the last six months, Express Scripts generated 78.67% more operating cash flow than the year before. The company's balance sheet improved as well, with their debt to equity ratio dropping from 2.86 before the merger, to 0.74. The company's improved operating cash flow led to improved free cash flow of $1.19 billion in the first six months of this year. Just by point of comparison, CVS generated enough free cash flow to pay a 1.42% yield with just a 17% free cash flow payout ratio during the same timeframe. If we assume that Express Scripts uses the same 17% payout ratio, this would be the equivalent of about $200 million in dividend payments over six months, or $400 million per year. With over 800 million shares outstanding, this would be equivalent to a roughly $.50 per share annual dividend, and at current prices would equate to a yield of about 0.80%.
While this doesn't sound like a lot, consider that this is based on a measly 17% payout ratio. Again using CVS as a comparison, the company has been increasing its dividend by over 28% in the last several years. I'm sure that this high rate of increase is directly related to their low payout ratio. While a 0.80% starting dividend might not satisfy investors initially, the fact that Express Scripts is expected to grow earnings faster than CVS would indicate that Express Scripts could also increase their dividend at a significant rate in the future. If the company started with a higher payout ratio of say 40%, the initial yield would be closer to 1.9%. As you can see, even with a very conservative payout ratio, the company could afford a respectable yield.
The bottom line for investors in Express Scripts is their company is the dominant force in its industry. The company generates significant free cash flow, and is growing faster than their primary competitor. Their balance sheet is stronger than it was before the merger with Medco as well. It seems reasonable for investors to ask for a dividend given all of these factors. A dividend would expand the company's base of investors and probably lead to some stability to the stock. In addition, this would show shareholders that management is committed to returning value directly as opposed to indirectly through share repurchases. I've said it before, and I'll say it again, where is the dividend Express Scripts?
MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of Express Scripts. Motley Fool newsletter services recommend Express Scripts. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
