Tempted To Sell Express Scripts Holding Company (NASDAQ: ESRX) At Its Current EV / Sales Ratio?

in VALUATION MULTIPLES by

Express Scripts Holding Company (NASDAQ: ESRX) shares currently trade at 0.6x its trailing revenue which is lower than the Healthcare sector median of 5.4x. While this makes ESRX look like a stock to add to your portfolio, equity investors might change their mind after taking a closer look at the assumptions behind the EV / Sales ratio. In this article, I define how to calculate a Sales Multiple and what to keep an eye out for when applying it in a comparable companies analysis.


Express Scripts Holding Comparable Companies Analysis

A comparable companies analysis, also known as a multiples valuation, determines the value of a subject company by benchmarking its financial performance against similar public companies or peers. We can conclude if a company looks undervalued or overvalued relative to its peers by comparing metrics like growth, profit margin, and valuation ratios.

Enterprise Value-to-Revenue Multiple, also known as the EV / Sales ratio or a Sales Multiple, measures the dollars in Enterprise Value for each dollar of revenue. To determine if a company is expensive, it’s far more useful to compare EV / Sales multiples than the absolute stock price. The general formula behind a Sales Multiples valuation model is the following:

Enterprise Value = Revenue x Selected Multiple

The EV / Sales ratio by itself is not very helpful at all. It is only useful when comparing it to other companies that are considered similar to the subject company. The basic idea is that companies with similar characteristics should trade at similar multiples, all other things being equal. Therefore, we can come to a conclusion about the stock if the ratios are different. In the chart below, I compare Express Scripts Holding’s EV / Sales ratio to its peer group that includes Cardinal Health, Inc. (NYSE: CAH), AmerisourceBergen Corporation (Holding Co)(NYSE: ABC), McKesson Corporation (NYSE: MCK) and CVS Health Corporation (NYSE: CVS).

ESRX Sales Multiple vs Peers Chartsource: finbox.io Benchmarks: Sales Multiples

Since Express Scripts Holding’s sales multiple of 0.6x is higher than the median of its peers (0.2x), it means that investors are paying more than they should for each dollar of ESRX’s revenue. As such, our analysis shows that ESRX represents an overvalued stock. In fact, finbox.io’s Sales Multiples Model calculates a fair value of $29.04 per share which implies -62.0% downside.

ESRX EV / Sales Valuation Calculation

I selected a fair multiple of 0.3x in my analysis by averaging Express Scripts Holding’s current EV / Sales ratio with its peer group.


Are Comps Really Comparable?

Before concluding that Express Scripts Holding should be banished from your portfolio, it is important to understand that our conclusion rests on two important assumptions.

(1) the selected peer group actually contains companies that truly are similar to Express Scripts Holding, and

(2) the selected peer group stocks are being fairly valued by the market.

If the first assumption is not accurate, the difference in sales multiples could be due to a variety of factors. For example, if you accidentally compare Express Scripts Holding with lower growth companies, then its sales multiple would naturally be higher than its peers since investors reward high growth stocks with a higher price. It’s also important to note that EV / Sales ratios are highly correlated with profit margins so differences in EBITDA margin often explain differences in valuation.

ESRX revenue Growth and Margins vs Peers Tablesource: sales multiples model

Now if the second assumption does not hold true, Express Scripts Holding’s higher multiple may be because firms in our peer group are being undervalued by the market.


How This Impacts Shareholders

As a shareholder, you may have already conducted fundamental analysis on the stock so its current overvaluation could signal a potential selling opportunity to reduce your exposure to ESRX. However, keep in mind the limitations of a sales multiples valuation when making an investment decision. There are a variety of other fundamental factors that I have not taken into consideration in this article. If you have not done so already, I highly recommend that you complete your research on Express Scripts Holding by taking a look at the following:

Valuation Metrics: how much upside do shares of Express Scripts Holding have based on the Ben Graham Formula? Take a look at our Ben Graham Formula data explorer which also compares the company’s upside to its peers.

Risk Metrics: what is Express Scripts Holding’s Altman Z score? It’s a famous formula used to predict the probability that a firm will go into bankruptcy within two years. View the company’s Altman Z score here.

Efficiency Metrics: how much free cash flow does Express Scripts Holding generate as a percentage of total sales? Has it been increasing or decreasing over time? Review the firm’s free cash flow margin here.

As of this writing, I did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.

Expertise: financial modeling, mergers & acquisitions. Andy is also a founder at finbox.io, where he’s focused on building tools that make it faster and easier for investors to do investment research. Andy’s background is in investment banking where he led the analysis on over 50 board advisory engagements involving mergers and acquisitions, fairness opinions and solvency opinions. Some of his board advisory highlights: - Sears Holdings Corp.’s $620 mm spin-off via rights offering of Sears Outlet, Hometown Stores and Sears Hardware Stores. - Cerberus Capital Management’s $3.3 bn acquisition of SUPERVALU Inc.’s New Albertsons, Inc. assets. Andy can be reached at andy@finbox.io or at +1 (516) 778-6257.

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