CVS Earnings Preview: Lower Generic Substitution & Customer Retention To Aid Growth
CVS Caremark (NYSE:CVS), the largest U.S. pharmacy based on total prescription revenue, will report its Q3 2013 earnings on November 5. The company has been reporting strong growth over the last two years and much of its success can be attributed to the dispute between its competitor Walgreen (NYSE: WAG) and pharmacy-benefits manager Express Scripts. However, resolution of the Walgreen – Express Scripts dispute along with rising sales of generic drugs have negatively impacted CVS Caremark’s top-line growth in the last few quarters.
After a slight decline in revenues in Q1 2013, CVS regained its footing by recording a marginal increase in its Q2 2013 revenues. We believe that the growth momentum will continue in Q3 as well. The lower impact of generic introductions in the quarter combined with CVS’ belief that it can manage to retain 60% of Walgreen’s customers are two key factors supporting our belief.
With 7,531 store across 42 states, its own pharmacy benefit management arm and in-store clinics to help with basic healthcare needs, we think CVS is well-equipped to leverage growth in the pharmaceutical industry. CVS remains committed to its goal to create a national primary care platform which provides integrated high quality care that is convenient, accessible and affordable.
Our price estimate of $63 for CVS Caremark is almost in line with the current market price of $61. We will update our valuation after the Q3 2013 earnings release.
View our detailed analysis for CVS Caremark
CVS Is Confident Of Retaining 60% Of Walgreen Customers
On account of Walgreen’s payment dispute with Express Scripts, many Walgreen customers switched over to its competitors last year. Handling prescriptions for millions of people, Express Scripts runs prescription drugs plans for employers, insurers and other customers. CVS’s retail pharmacies gained 6.5 million to 7 million new prescriptions from former Walgreen customers in 2012. [1]
However, Walgreen claims to be winning back old customers after it entered into a fresh agreement with Express Scripts in September 2012, which allows Express customers to fill prescriptions at Walgreen stores. Nevertheless, CVS claims that it is confident in its ability to retain a minimum of 60% of the Walgreen scripts this year. [2]
CVS Caremark, Walgreen and Express Scripts together account for over 50% of total prescription drugs filled in the US, out of which CVS Caremark has a close to 19% market share. ((Retail Pharmacy Stocks, A Good Investment As Affordable Care Act Nears, Seeking Alpha, April 1, 2013)) If CVS manages to retain a majority of new customers acquired last year, we think it will be able to sustain its market share gain in the future as well.
Lower Negative Impact By Generic Drugs Introduction
Although generic drugs offer higher gross margins, they are priced lower compared to branded drugs. The total generic dispensing rate, which implies the percentage of generic drugs in a consumer’s prescription, grew to 78.5% in 2012 from 74.1% and 71.5% in 2011 and 2010, respectively. The pharmacy services’ generic dispensing rate increased to 81% in Q2 2013, a 2.75% y-o-y rise.
However, as indicated by Walgreen in its Q4 2013 earnings release this month, the negative impact of generic drugs slowed down. Generic drugs had a 2% negative impact on Walgreen’s comparable prescription sales as compared to a 9% negative impact in Q1 2013. The company anticipates low rate of introduction of new generics in the first half of fiscal 2014. Thus, we expect a lower negative impact of generic drugs introduction on CVS Caremark’s top line growth in Q3 2013.
Nevertheless, an estimated $15 billion worth of branded products will come off patent in the next three years, opening them to competition from generic drugs. Thus, generics will continue to offset CVS Caremark’s top-line growth in the future as well, albeit at a slower pace.
MinuteClinic Expansion & ExtraCare Loyalty Program To Improve Customer Retention
MinuteClinic are small walk-in medical clinics within the CVS Caremark pharmacy stores available at 684 locations across U.S. They utilize nationally recognized protocols to diagnose and treat minor health conditions, perform health screenings, monitor chronic conditions and dispense vaccinations at much lower prices than a hospital. CVS registered a 32% (y-o-y) increase in revenue from MinuteClinics and opened 25 new places in Q2 2013. It expects to take the total to 150 new MinuteClinics by the end of the year and plans to operate about 1,500 clinics by 2017. 30% of the expansion will be in new markets.
As 30 million Americans are included under healthcare coverage, it can lead to a shortage of primary care physicians in the future. Expanding the MinuteClinic footprint can help cover the additional demand for physicians. The U.S. is already facing an acute shortage of doctors and this should benefit independent clinics such as MinuteClinic.
CVS Caremark’s ExtraCare loyalty program currently has about 70 million active subscribers, accounting for 68% of front store sales transactions and 84% of total front store sales. [3] These have helped the company in maintaining a high customer retention ratio along with attracting new customers to shift to CVS Caremark’s network.
Understand What Drives a Stock at Trefis
Notes:- 2012 Market Share of Top Pharmacies, January 15, 2013, Drug Channels, January 15, 2013 [↩]
- CVS Caremark’s Management Presents at 2013 Morgan Stanley Healthcare Conference (Transcript), Seeking Alpha, September 10, 2013 [↩]
- CVS Caremark Barclays Investor Presentation [↩]