IT'S TIME FOR A VALUATION

checkup. We wrote about prescription benefits manager

Express Scripts

Shares have since gained 52%, outpacing the Standard & Poor's 500 index's 40% improvement. But they've also swelled to a price/earnings-to-growth, or PEG, ratio that's a stock's P/E ratio divided by its projected long-term earnings growth rate of 1.06, from 0.77 at the time of our last story.

Is the prognosis for Express Scripts' stock still promising? We'll look into that today; the company turned up recently in our price/sales screen.

Spotlight Stock
Express Scripts Provides pharmacy benefit management services, including retail drug-card programs, mail pharmacy services, drug formulary management programs and other clinical management programs for HMOs, health insurers, third-party administrators and employers.
Tuesday's Close	$86.27
Market Value	$6.3 billion
Trailing 12-Month Sales	$15.1 billion
Forward P/E	18
Est. Long-Term Earnings-Growth Rate	17%
Additional Data: | | | |

Earnings are the main driver of share prices over long time periods. So why run a value search based on the P/S ratio instead of the P/E ratio? Because sales are a more reliable measure of income than earnings. Earnings can fluctuate significantly from quarter to quarter due to one-time charges and credits. Sales, though, appear at the top of companies' income statements, before adjustments are made for such items.

Some argue that sales can also be a better predictor than earnings of share price movements. In his 1996 book "What Works on Wall Street," James O'Shaughnessy used 43 years' worth of market data to show that stocks with low P/S ratios had outperformed those with low P/E ratios, and that those with low P/S ratios and sales momentum had returned an average of 18.4% during his study period, vs. 13.0% for the broader market.

Our price/sales screen has produced some impressive performance figures of its own. Last June it drew our attention to Rayovac. We noted in our write-up of the company ("Batteries Sold Incessantly that its P/S ratio of 0.75 was far lower than Energizer Holdings' 1.34 and Gillette's 4.61. Our look at the shares, which had already gained 111% in the past year, concluded that they had "higher still to charge." They're up 61% since our story, vs. 7% for the S&P 500 index.

Use our stock screener and the price/sales recipe anytime to run the search for yourself. Recently it produced a list of 10 candidates for further research, including Express Scripts.

Based in Maryland Heights, Mo., Express Scripts is the nation's third-largest prescription benefits manager. It serves as a go-between for managed-care organizations, insurance companies, employers and government agencies. The company helps clients design plans that encourage the use of generic drugs and mail ordering, carving out costs and securing fees for itself in the process.

Sales for Express Scripts increased by 14% to $15.1 billion in 2004. Much of that growth came from the acquisition in early 2004 of Orlando-based CuraScript for $335 million. The company says CuraScript is operating at an annual revenue run rate of more than $835 million. Sales for Express Scripts are expected to increase by a more modest 11% to $16.7 billion in 2005 and by 10% to $18.4 billion in 2006.

Holders of the stock are sweating out the company's renewal this year of three monster contracts. There's one with the State of New York that covers $1.2 billion in annual drug spending, one with Georgia covering $700 million in spending and one with Blue Shield of California covering $470 million.

Analysts say there's a high probability of the company renewing its deals with Georgia and California, and that it has a 50/50 shot in New York, where Attorney General Eliot Spitzer has accused the company of misdoings, including inflating the cost of generic drugs and improperly taking rebates. Industry watchers have put the possible cost of a settlement in New York at $25 million to $100 million. The company set aside $25 million in legal reserves during its third quarter to provide for such an event.

A.G. Edwards analyst Andrew Speller calls Express Scripts the "bellwether for the industry and the established growth play." But in a March 3 research note he pointed out that the stock's current P/E ratio of 18 times 2005 estimates is more or less in line with its historical average. What's more, he noted that earnings growth is slowing; the company produced earnings-per-share growth of just 21% in 2004, compared with 25% in 2003 and 35% in 2002. Speller rates the stock a Hold. (Speller doesn't own shares of Express Scripts; A.G. Edwards doesn't have an investment-banking relationship with the company.)

Jefferies & Company's Glen Santangelo calls it a Buy. "Long-term fundamentals continue to be very solid as evidenced by strong mail and retail order growth, improving operating margins and healthy cash flows," wrote Santangelo in his own March 3 note. "Trading at a 14% discount to its peers, we believe the valuation remains attractive." (Santangelo doesn't own shares of Express Scripts; Jefferies doesn't have an investment-banking relationship with the company.)

Who's right? Express Scripts' aforementioned PEG ratio of 1.06, although higher than it used to be, is still well lower than the average PEG of 1.42 for retail drug sellers and the S&P 500 index's PEG of about 1.60. And on a P/S basis, Express Scripts' 0.4 is a pittance next to competitors Caremark Rx, with a P/S ratio of 0.7, and UnitedHealth Group, at 1.6.

That suggests the stock might indeed be cheap. And the company's trailing operating margin of just 3.3% vs. an industry average of 4.3% is an indication that there are cost cuts to be found. Add to that a pretty aggressive share repurchase program the company spent $176 million on shares last quarter alone and Express Scripts looks poised to continue producing healthy returns for its shareholders.