CVS Caremark (NYSE:CVS), the largest U.S. pharmacy based on total prescription revenue, will release its Q4 2013 earnings on February 11. 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 (in September 2012) along with rising sales of generic drugs have restricted 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. A strong performance in the Pharmacy Services Segment (which the company refers to as PBM) and a favorable tax rate re-accelerated CVS’ growth in Q3 2013 (5.8% annual growth).
With 7,601 stores across 42 states, CVS is the second largest drugstore chain in the U.S. after Walgreen. With its Pharmacy Services Segment (PBM) and in-store clinics to help with basic healthcare needs, we think CVS is well-equipped to leverage growth in health care consumption. It remains committed to its goal to create a national primary care platform that provides integrated high quality care that is convenient, accessible and affordable. CVS’ management remains confident that the company can gain market share across its offering.
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Our price estimate of $65 for CVS Caremark is almost in line with the current market price. We will update our valuation after the Q4 2013 earnings release.
Specialty Drugs To Drive The Pharmacy Service Business
Within its pharmacy service management business, which accounts for approximately 60% of its total revenue and 30% of its valuation, specialty drugs are one of CVS Caremark’s top priorities and the company is increasing its focus on developing this business. Specialty drugs treat complex diseases such as multiple sclerosis, rheumatoid arthritis, hepatitis C and cancer, among others. A new report released by CVS in November 2013 projects that specialty drug spending will more than quadruple by 2020, crossing $400 billion a year.
CVS witnessed strong growth in its specialty business in Q3 2013, with 22% higher revenues compared to the prior year quarter. Key drivers here were drug price inflation, utilization, product launches and new PBM clients. CVS operates approximately 30 retail specialty pharmacy stores (under the CarePlusCVS/pharmacy name) and 12 specialty mail order pharmacies located in 22 states in the U.S.,as well as in Puerto Rico and the District of Columbia. CVS Caremark has an approximate 15% market share in specialty drugs.
CVS believes that its differentiated approach to specialty pharmaceuticals will drive lower overall costs while improving health and providing value for both payers and patients. The company has an entire suite of specialty capabilities including utilization management programs, specialty guideline management, formulary strategies, as well as a site care and medical claims added in products.
Last month, CVS acquired Coram LLC, the specialty infusion services and interal nutrition business unit of Apria Healthcare Group Inc. CVS believes the acquisition will further expand its competitive offerings in specialty services.
Lower Generic Substitution To Impact Margin Growth
Although generic drugs are priced lower compared to branded drugs, they offer higher gross margins. 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. Generic drugs continued to replace branded drugs in 2013, albeit at a slower pace.
Generic introductions negatively impacted CVS’ pharmacy same-store sales by 3.2% in Q3 2013 as compared to a 6.7% negative impact in Q2 2013. Though generic dispensing rate increased to 81% last quarter, the sequential year-over-year rate of increase declined to 1.7% compared to 5% in Q3 2012. CVS expects fewer generic conversions in the current quarter.
CVS expects its overall gross margin to be down significantly in Q4 2013 year to year, on account of a contraction in both the retail and PBM business as well as fewer new generics available to offset continued reimbursement pressure.