Strong Performance in PBM Drives CVS’ Growth In Q1’14

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The largest pharmacy services provider in the U.S., CVS Caremark (NYSE:CVS), missed its Q1 2014 guidance on account of severe weather conditions and a weaker flu season compared to last year. Nevertheless, the company reported a strong Q1 2014 with a 6.3% annual increase in revenue and a 22.9% growth in its adjusted earnings per share.

CVS is the second largest drugstore chain in the U.S. after Walgreen (NYSE: WAG), and remains committed to its goal to create a national primary care platform that provides integrated high quality care that is convenient, accessible and affordable. With its Pharmacy Services Segment or Pharmacy Benefits Management (which the company refers to as PBM) and in-store clinics to help with basic healthcare needs, CVS’ management remains confident that the company can gain market share across its offerings.

CVS generated free cash flow of $1.8 billion in Q1 2014 and expects to produce free cash flow of between $5.5 billion and $5.8 billion for the full year. Despite missing its earnings target in Q1 2014, the company is confident of meeting its overall 2014 target.

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Our price estimate of $70 for CVS Caremark is at a slight discount to the current market price. We are in the process of updating our valuation to incorporate the latest earnings release.

View our detailed analysis for CVS Caremark

Quick Snapshot Of The Q1 2014 Earnings

CVS’ Pharmacy Services Segment witnessed a robust 10.3% growth mainly driven by strong performance in specialty, inflation and net new business, which was partially offset by lower mail choice claims as well as the negative impact on the claims from bad weather. Despite the negative impact of the unforeseen extreme weather conditions, CVS’ retail segment sales increased 2.7% (year over year).

At 18.2%, the company-wide gross margin increased by 5 basis points, driven by growth in the specialty segment, better acquisition cost and rebate economics, as well as the increase in the generic dispensing rate. The retail and PBM operating profit increased 14.2% and 28.5%, respectively. Pharmacy sales compensation were negatively impacted by 1.2% due to recent generic introductions and by 1% from the combined impact of adverse weather and a weaker flu season this year.

Strong Growth In The PBM Business

CVS is the only retail drugstore chain that has its own Services arm (PBM), which allows it to offer scale to its retail clients. The company maintains a national network of over 67,000 retail pharmacies that serve customers covered under the programs administered by Caremark. In addition to this, it also designs customized pharmacy service plans for its clients, helping them to minimize costs.

CVS has a 30% market share in the managed Medicaid market and believes it is well-positioned to gain additional share through Medicaid expansion. The company estimates the managed Medicaid market will grow by 40% through 2016. [1] CVS claims that its health plan client footprint spans 25 states covering approximately 70% of the eligible exchange population. [1] CVS Caremark ranked first (among large publicly traded PBMs) on overall satisfaction in the annual pharmacy benefit manager customer satisfaction report released by PBMI in April 2014. The report is a broad survey which includes the opinions of nearly 400 plans sponsors who represent approximately 65 million members.

During Q1 2014, CVS announced the renewal of a three-year contract to provide integrated pharmacy benefit services for the federal employee health benefit program (FEP). CVS provides mail, retail and specialty PBM services along with highly customized clinical programs to FEP’s more than 5 million federal employees, retirees and dependents.

CVS Is Confident Of Gaining Share In The Fast Growing Specialty Segment

Within its pharmacy service management business, specialty drugs are one of CVS Caremark’s top priorities and the company is increasing its focus on developing this business. At present 60% of specialty revenue in CVS’ PBM segment are dispensed through specialty pharmacy. Specialty revenue grew 34% year over year in Q1 2014 and was one of the primary growth drivers for CVS’s strong performance in the quarter. 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. As per the recently released CVS annual trend management report, while spending for traditional medications was up only 0.8% in 2013, the overall trend was up 3.8% and was largely driven by a 15.6% increase in specialty medications.

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., Puerto Rico and the District of Columbia. CVS Caremark has an approximate 15% market share in specialty drugs. The company believes that its differentiated approach to specialty pharmaceuticals will drive lower overall costs while improving health and providing value for both payers and patients. It 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.

The recent acquisition of Coram LLC, the specialty infusion services and internal nutrition business unit of Apria Healthcare Group Inc, has expanded CVS’ competitive offerings in specialty services. Among CVS’ clients, specialty now represents about 22.5% of total drug spending and the company projects the same to grow to as much as 50% by 2018. [2]

Q2 2014 Guidance

– Adjusted EPS to be in the range of $1.08 to $1.11. GAAP diluted EPS from continuing operations is expected to be in the range of a $1.01 to $1.04.

– Retail segment revenue to increase 2.5% – 4% year over year. Adjusted script comps and total same store sales are expected to increase in the range of 2.75% to 3.75% and 1.25% to 2.75%, respectively.

– PBM revenue to grow between 10.75% and 12%.

– Retail and PBM operating profit to increase by 4.5% – 6.5% and 18.25% – 23.25%, respectively.

2014 Guidance

– Net revenue to grow 5.25% to 6.5%.

– Retail operating profit to increase 7% to 8.75% year over year and PBM operating profit to increase 6.75% to 10.75%.

– Adjusted EPS in the range of $4.36 to $4.50. GAAP diluted EPS from continuing operations to be in the range of $4.09 to $4.23.

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Notes:
  1. CVS Caremark’s CEO Discusses Q3 2013 Results – Earnings Call Transcript, Seeking Alpha, November 5, 2013 [] []
  2. CVS Caremark’s CEO Discusses Q1 2014 Results – Earnings Call Transcript, Seeking Alpha, May 2, 2014 []