Obamacare Can Help CVS Reach Our $49 Valuation

by Trefis Team
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The stock price for CVS Caremark (NYSE:CVS) rose almost 5% after it reaffirmed its 2012 guidance and provided guidance for 2013 which was above market’s expectations Thursday, 13 December. With the U.S. healthcare system undergoing a major change under the Patient Protection and Affordable Care Act 2011, or Obamacare as it is popularly known, and a greater section of the population picking up prescriptions as they age, the company foresees an opportunity to expand its role as a healthcare provider. [1] We’ve already accounted for the expected growth in the pharmacy services business in our fair value estimate for the company.

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

CVS’s decision to acquire Caremark in 2007 seems to have paid off as the company has been able to leverage both of its primary businesses to drive growth in the other. The company is in a unique position to benefit with the pending expansion of healthcare coverage in 2014 which could result in it surpassing Walgreens (NYSE:WAG) as the leading drugstore chain in the country.

View our detailed analysis for CVS Caremark

Expanding Medicare Client Base To Drive Pharmacy Services Growth

Almost 30 million people are expected to join the ranks of insured patients on 1 January 2014 as per the provisions of Obamacare. The large population of aging baby boomers and rising usage of specialty drugs are together expected to raise the number of sign ups for Medicare Part D prescription plans. The company’s Pharmacy Benefits Management division participates in the Medicare Part D program as a Prescription Drug Plan, and we expect this to increase the number of claims processed by the business. The company reported a 16% growth in the claims processed during the current fiscal year until September with the growth in claims activity from Medicare program being the primary reason. We expect the growth to continue as the baby boomer generation starts utilizing the plan to its full potential.

Ailing American Population To Drive Prescription Growth

The number of Americans suffering from chronic diseases is rising and these patients spend more on healthcare than an average healthy person. As they visit doctors more frequently and take regular medications, we expect it to result in a growth in the number of prescriptions filled annually in the country. The company also expects to retain almost 60% of Express Scripts customers it gained from Walgreen as a result of a dispute between the companies. [2] The aging population and expanding health insurance coverage will further drive this growth.

Key Risks: Generic Introductions And Tougher Competition

Generic dispensing rates have risen by 5 percentage points currently from ~75% a year ago. The lower priced generics have resulted in the drugstore chains struggling with revenue growth. The company has so far been able to offset the loss from generic introductions because of drug cost inflation, but now expects first quarter 2013 revenues to fall in the 2.5-4% range. Meanwhile, the higher gross margins offered by generics have had a positive effect on the company’s margins. We expect the margins to improve marginally going forward and thereafter be steady.

CVS’s growth has come at the expense of competitors like drugstore leader Walgreen and pharmacy benefits manager Express Scripts. Walgreen has been trying to win back patients it lost to the likes of CVS and Rite Aid with a new loyalty program and new store formats [3] while Express Scripts is looking to consolidate its position with acquisitions (For example: Medco Health Solutions). [4]

Walgreen has successfully arrested the decline in prescriptions filled at its stores and about 40 million people have signed up for its loyalty program. With this development, we believe CVS’s target of retaining 60% of Walgreen’s customers is not realizable and is a major risk facing the company.

We currently have a $49 Trefis price estimate for CVS Caremark stock, which is at par with the market price.

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Notes:
  1. CVS Caremark Provides Strong Growth Outlook for 2013 and Beyond, Announces 38% Dividend Increase and Outlines Strategic Growth Framework, CVS Caremark, December 2012 []
  2. CVS Caremark sees Obamacare as expansion opportunity, Reuters, December 2012 []
  3. Balance Rewards, Walgreens, December 2012 []
  4. Express Scripts and Medco Health Solutions Complete Merger; Will Address National Mandate for More Affordable, Higher Quality Healthcare, PR Newswire, April 2012 []
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