CVS Caremark (NYSE:CVS) is the largest integrated pharmacy service provider in the U.S., and operates close to 7,500 retail stores along with a pharmacy benefits management service. About 70% of its revenues comes from prescription drugs while front-end store sale of personal care, beauty products, general merchandise and other goods account for the remaining 30%.
The presence of CVS in both retail pharmacy and pharmacy benefits segment positions it better than competitors Walgreen (NYSE:WAG), Wal-Mart (NYSE:WMT) and Rite-Aid (NYSE:RAD), to gain from the implementation of the Patient Protection and Affordable Care Act 2011 and an aging American population.
In this article we look at how CVS’s pharmacy revenues stand to gain from the ongoing trends in the industry.
Factors Affecting Growth Of Retail Prescriptions Filled In U.S
1) Baby-boomer Generation To Come Of Age
The percentage of American people aged 65 yrs and above increased from 16.3% in 2000 to about 18.5% in 2010. At the same time, the percentage of Americans in the 45-65 yrs age bracket increased from 18% of the total population in 2000 to about 21% in 2010. The latter group will gradually move into the more than 65 yrs of age bracket over the coming decade. As seniors are more susceptible to ailments and therefore more likely to be under medication, we expect the gradual aging of this (baby-boomer) generation to drive growth in the number of prescriptions filled in the U.S. in the next 10 yrs.
2) Expansion Of Medicare Client Base Under Obamacare
Almost 30 million people are expected to join the ranks of insured patients on 1 January 2014, as per the provisions of Patient Protection and Affordable Care Act 2011, or Obamacare, as it is popularly known. This expansion of insurance coverage will result in growth in the number of prescriptions filled. We currently estimate the number of retail prescriptions filled in the U.S. to grow from 3.76 billion in 2012 to 4.5 billion in 2019.
CVS’s Market Share In Prescriptions Filled Annually To Come Under Pressure
CVS was one of the biggest beneficiaries from the dispute between Express Scripts and Walgreen in 2012. As a result of the dispute, Express Scripts customers were forced to get their prescriptions filled at another pharmacy, or pay more for drugs if they continued to use Walgreen. The dispute was further beneficial for CVS when Express Scripts acquired another pharmacy benefit manager Medco in April, further costing Walgreen millions of prescriptions. Gains from the dispute resulted in CVS’s market share in prescriptions filled in the U.S. increasing from about 18% in 2011 to 19% in 2012.
However, in July the two companies reached an agreement which allowed Express Scripts customers to return to Walgreen starting September 15, 2012. Since then, the growth in the number of prescriptions filled at Walgreen has picked up the pace signalling that a major chunk of Express Script customers have returned. CVS acknowledged the trend recently and now expects to retain almost 60% of Express Scripts customers it gained from Walgreen.  We believe that the return of Express Scripts customers will lead to CVS’s market share declining to about 18% by 2016. In contrast, we expect Walgreen’s share to rise to near 20% in the same time period, up from 18.5% currently.
Growth In Generics Penetration To Keep Revenue Per Prescription Under Check
In 2012, an estimated $35 billion of prescription drug sales were exposed to generic competition. This was the primary cause behind Revenue Per Retail Prescription filled at CVS declining from $62 in 2011 to $61 in 2012. A similar trend was observed at Walgreen, where Revenue Per Retail Prescription filled declined from $66 in 2011 to $65 in 2012.
An estimated $260 billion of prescription drugs sales are scheduled to go off patent between now and 2018.  In all, blockbusters with a combined $170 billion in annual sales will lose patent between 2012 and 2015. ((Cliffhanger, The Economist, December 2011)) The rate at which branded drugs get replaced by generic alternatives is expected to continue at near 2012 levels in the near term.
Usually, generic versions of drugs generate lower total sales per prescription. As a retailer, CVS gets a part of the final retail value of a drug sold as its revenue, but the end of patent protection for a branded drug negatively impacts the company’s revenue. The patent cliff as the trend is being referred to supports our forecast for the revenues CVS earns per retail prescription filled. We estimate revenue per retail prescription to decline from $61 currently to $58.50 in the long term.
Prescription Drug Revenues To Be Under Pressure In The Near Term
We estimate CVS’s prescription drug revenues as a product of Revenue Per Prescription, CVS’s Market Share of Retail Prescriptions filled in the U.S. and the number of retail prescriptions filled in the U.S. The combined effect of the trends enlisted above lead us to believe that CVS’s revenues from the retail pharmacy segment will decline in the near term, before picking up pace and growing to $48 billion by the end of our forecast period. If the company is able to maintain current level of market share and retail prescriptions filled in the U.S. grow at 3% instead of our estimate of about 2.5%, CVS’s revenues from retail pharmacy will grow steadily to about $52 billion by the end of our forecast period.
We currently have a $53 Trefis price estimate for CVS Caremark stock, which is in line with the current market price.Notes:
- CVS Caremark sees Obamacare as expansion opportunity, Reuters, December 2012 [↩]
- BIO 2012: Implications of the ‘Patent Cliff’, StreetWise Reports, June 2012 [↩]