Express Scripts Trades Far Below Moat ETF Value

The latest fair value reading from Morningstar (MORN) among the stocks it puts through its proprietary analysis is signaling that values are hard to come by. The composite for those stocks shows prices are now 6% above Morningstar’s fair value estimates. The story is slightly better among the 200 or so companies that have carved out competitive advantages that Morningstar considers to be a “wide moat.” The wide moats recently traded on par with their estimated fair value.

Which isn’t saying much if you happen to prefer buying a stock at a sizable discount to its fair value. The promising Market Vectors Wide Moat ETF (MOAT) tracks Morningstar’s Wide Moat Focus index rebalances quarterly to hold the 20 wide moat stocks trading at the steepest discount to Morningstar’s fair value estimate. At the recent rebalance for the fourth quarter just six of the 20 stocks were trading at a discount of at least 15% to their fair value estimate. Not exactly a huge margin of safety.

Express Scripts (ESRX) is an intriguing outlier among the 20 stocks in the Market Vectors Wide Moat ETF this quarter. When Morningstar ran the rebalance in late September the leading pharmacy benefit management company traded at a 26% discount to Morningstar’s fair value. At a recent price of $62, the gap has widened to a 30% discount to Morningstar’s fair value estimate of $89 per share.

Normally there has to be some heavy storm clouds hovering over a company for it to trade at such a steep discount when the market in general is fairly valued. Indeed Western Union (WU) and Exelon (EXC) the two cheapest stocks in the Market Vectors ETF at the latest rebalance are not exactly firing on all cylinders.

Express Scripts, the third cheapest stock in the Wide Moat ETF this quarter doesn’t seem to have such strong headwinds to plow through.

For starters, the deep discount is in large part due to Morningstar changing its fair value price in early September from $73 to $89. Morningstar says about half of that upgrade was adjusting for “time value” in its proprietary discounted cash flow analysis. The rest was driven by expectations of improving fundamentals: Morningstar foresees revenue growth averaging 5.1% a year over the next five years, and for operating margins to average 6.4% in the coming years, returning that metric to its pre-crisis highs.

ESRX Operating Margin TTM Chart

ESRX Operating Margin TTM data by YCharts

The thing is, in the immediate aftermath of Morningstar’s early September announcement it was raising its fair value estimate for Express Scripts, the stock has traded down more than 5%, during a flat stretch for the S&P 500.

ESRX Chart

ESRX data by YCharts

That’s been the market’s reaction to news that Walgreens (WAG) is moving its health insurance benefits management over to a private exchange that will be run by Aon Hewitt (AON). The Aon Hewitt Corporate Health Exchange expects to be serving 18 companies representing 330,000 employees in 2014. IBM (IBM) also made news recently when it said it will shift retirees into another private health exchange, Extend Health, which also has Time Warner (TWX) and Caterpillar (CAT) as clients. (Note: these private exchanges are unrelated to the public exchanges that launched October 1 as part of the Affordable Care Act.)

The concern is that these relatively new private exchanges -- and the evolving delivery of health care benefits, amid implementation of the ACA -- muddy the waters for Express Scripts. Morningstar isn’t concerned. In a follow-up note it points out that the private exchanges are currently a very small piece of the pie, and it is not a given that all private exchanges would bring prescription benefit management in house. That service could still be contracted out to the stand-alone PBMs, of which Express Scripts is the market behemoth, following its 2012 merger with Medco.

In 2012 Express Scripts processed 1.3 billion adjusted prescription drug claims. Through the first six months of 2013 it handled 759.4 million claims, putting it on track to exceed 1.5 billion for the full calendar year. This clearly isn’t a company showing signs of a shaky market:

ESRX EBITDA per Share TTM Chart

ESRX EBITDA per Share TTM data by YCharts

And as the largest PBM it’s in a position to exploit its wide moat advantage: that heft allows Express Scripts to negotiate price discounts with drug manufacturers; some of that is passed along to the retail clients . . . and some is kept by Express Scripts. Morningstar reiterated its $89 fair value estimate and sees the sell-off as creating an ever-more compelling entry point. (Full disclosure: Morningstar is an investor in YCharts.)

Express Scripts also has been one of the few stocks the Weitz Value fund has been buying of late. The deep value fund has been steadily raising its cash position for more than nine months as it sells positions that have risen closer to the managers’ intrinsic value estimates, and is finding it hard to identify deep values it wants to reinvest those profits in. The $1 billion fund had more than 25% parked in cash at the end of the second quarter.

Weitz Value added Express Scripts to its portfolio in the fourth quarter of 2012, and then added another 25% to its stake in the second quarter. Express Scripts represented 3.2% of the portfolio at the end of the second quarter, making it the eight largest holding in the fund.

Carla Fried, a senior contributing editor at, has covered investing for more than 25 years. Her work appears in The New York Times, and Money Magazine. She can be reached at Read the RIABiz profile of YCharts. You can also request a demonstration of YCharts Platinum.



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