The CVS Caremark Growth Engine Rolls On And Raises Guidance

by Trefis Team
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CVS Caremark (NYSE:CVS) recently unveiled its Q2 earnings and continued to post strong 16% revenue growth, benefiting from the prior Walgreen-Express Scripts impasse, new PBM client starts, specialty drug cost inflation and the acquisition of UAM’s Medicare prescription drug business.

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 prescription drugs, OTC drugs and general merchandise. It also competes with Express Scripts, Argus, etc., in the pharmacy benefits management segment.

View our detailed analysis for CVS Caremark

Retail Business Benefits From Express-Walgreen Fallout

Last quarter, CVS’s retail sales continued to benefit significantly from prescriptions associated with the Walgreen-Express fallout. Sales rose 6.9% (y/y), with 5.6% higher same store sales that included 7.2% increase in pharmacy same store sales. The 115 new stores added in the last one year accounted for approximately 115 basis points of total net revenue percentage increase.

Pharmacy revenue growth also benefited from CVS’s leading share in the the Medicare Part D prescription drug program (that covers the aging American population) and the favorable industry trends. Nonetheless, pharmacy revenues absorbed up to 500 bps of negative impact by the conversion of brand-named drugs to equivalent generic drugs, which typically have a lower selling price. The retail margins were positively impacted by higher generic dispensing rates and same store sales growth, but partially offset by continued reimbursement pressure and lower front store margins.

With the recent announcement that Walgreen will restart filling prescriptions for Express Scripts customers from September 15, CVS has raised its 2012 earnings guidance to include the continued benefit of Walgreen-Express impasse during the third quarter and is also counting on retaining at least 50% of the prescription business gained during the impasse.

Robust Pharmacy Services Business

The Pharmacy services segment also performed well during the quarter with 28% growth in revenue (y/y) as it processed 15% more mail choice and 13% more pharmacy network claims. While the increase in mail choice claim volume was primarily due to a significant number of new client starts as well as increased claims associated with its Maintenance Choice program, the increase in the pharmacy network claim volume was driven by new client starts as well as higher claims activity associated with its Medicare Part D program post the acquisition of UAM Medicare PDP Business.

There was an 8.6% increase (y/y) in average revenue per mail choice claim driven by drug cost inflation, particularly in the specialty drugs segment, and 14% growth in revenue per pharmacy network claim due to drug cost inflation, partially offset by higher generic dispensing rate.

CVS’s pharmacy services segment has performed impressively this year, with $7.1 billion in new contracts and $5.5 billion in incremental revenues from the Universal American contracts, along with an impressive 98% retention rate. However, the impressive top-line growth and contract wins/renewals have come with some margin contraction due to competitive client pricing. The pharmacy services gross margin declined to 4% during the first half of 2012, down from 5% last year, even though gross profit dollars increased.

We have a revised $48 Trefis price estimate for CVS Caremark stock.

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