CVS Caremark (NYSE:CVS) has impressively turned around the outlook of its pharmacy services business within a year, becoming the industry’s second largest player having won multiple high-profile contracts. It also acquired a leadership position in the federally-sponsored Medicare Part D prescription business through acquisitions, achieved high growth in specialty pharmacy segment, and leveraged its integrated business model to greatly expand its Maintenance Choice program.
Last quarter, its PBM revenues grew 32% as it processed 17% more mail choice and 26% more pharmacy network claims compared to the prior year period. It also earned significantly higher revenue per claim due to drug cost inflation, particularly specialty drugs, offset by new generic introductions.
CVS Caremark is an integrated pharmacy services provider and drugstore chain that competes with Walgreen (NYSE:WAG), Wal-Mart (NYSE:WMT) and Rite-Aid (NYSE:RAD) in its prescription drugs, OTC drugs and general merchandise segment. It also competes with Medco Health Solutions and Express Scripts in the pharmacy benefits management segment.
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Pharmacy Services Business Grows
CVS Caremark has aggressively expanded its PBM business by winning multiple high profile multi-year contracts, including CalPERS, Aetna, FEP and Universal American (UAM). In the process, it has also focused on acquiring a leading position in the Medicare Part D business through UAM acquisition and purchase of Health Net’s Medicare PDP business. Medicare and Medicaid are expected to show strong growth over this decade and could account for two-thirds of all U.S. prescriptions by 2020, up from about one-third today. In particular, Medicare Part D prescription drugs plans would get a huge boost from the aging U.S. population and health reforms that are expected to significantly increase prescription utilization and help plug the Medicare Part D coverage gap, or doughnut hole.
The company has also strengthened its position in the Specialty Pharmacy business by leveraging its integrated retail-pharmacy services business model to deliver more value to its customers. Specialty pharmacy is expected to be a $15 billion business for CVS Caremark that has been seeing a double digit growth of late. The company has also benefited greatly from its Maintenance Choice program that extends the mail-order benefit for Caremark’s members, enabling them to pick up their maintenance medications at any CVS retail pharmacy with no increase in co-pay or payer pricing.
Last quarter, CVS’s PBM revenue grew 32% (y/y) as the pharmacy services segment processed 17% more mail choice and 26% more pharmacy network claims compared to same quarter previous year, with a significant number of new client starts and increased claims associated with Maintenance Choice and Medicare Part D programs. It also earned 11% higher average revenue per mail choice claim and 7% higher for pharmacy network claim due to drug cost inflation, particularly in specialty drugs. It was offset by higher generic drug dispensing rate that increased to 69% from 64% for mail choice and to 77% from 75% in pharmacy network (y/y) due to new generic introductions.
But Margins Contract
While the top-line grew at 32%+, the bottom-line of Pharmacy services has been under pressure over the last few quarters due to client pricing compression. CVS’s recent contract wins and renewals/retention are likely to have come with further margin compression this year. Last quarter, the margin also bore the impact of higher expenses associated with new client starts with its mail operations and expanded Medicare Part D operations, partially offset by increased generic dispensing rate.
We are in the process of revising our $45 price estimate for CVS Caremark stock.