CVS To Retain Its Growth Momentum In Q3’14 Driven By Its PBM Business

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CVS Health (NYSE:CVS), the second largest drugstore chain in the U.S. after Walgreen, will report its Q3 2014 earnings on November 4th. After a slight decline in revenues in Q1 2013 and only marginal growth in Q2 2013, the company’s growth re-accelerated in the second half of the year driven by strong performance in the Pharmacy Services segment (which CVS refers to as PBM). CVS has retained the growth momentum so far in 2014, and witnessed an approximate 9% and 14% growth in its revenue and net income in the first half of the year, compared to the same period in 2013.

We expect CVS to retain its growth momentum in the current quarter as well. Based on the strong growth witnessed by it so far this year, the company increased the midpoint of its revenue guidance by approximately 260 basis points over the prior guidance, in Q2 2014. It now expects net revenue to grow in the range of 8% to 9%, with majority of the growth being driven by its strong performance in the PBM business. Its adjusted EPS guidance has been increased to $4.43 to $4.51, from its initial guidance of $4.36 to $4.50.

CVS 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 (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.

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Our price estimate of $77 for CVS Caremark is approximately 10% lower than the current market price. We will update our valuation after the Q3 2014 earnings release.

View our detailed analysis for CVS Caremark

Specialty Drugs To Drive 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. The company ranked first (among large publicly traded PBMs) in 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.

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. Specialty drugs treat complex diseases such as multiple sclerosis, rheumatoid arthritis, hepatitis C and cancer, among others. At present 60% of specialty revenue in CVS’ PBM segment are dispensed through specialty pharmacy. Specialty revenue grew 34% and 53%  year over year in Q1 2014 and Q2 2014 respectively. Benefits from new business, the addition of Coram and the introduction of a new specialty drug Sovaldi (a new hepatitis C drug) drove specialty revenue in the first half of 2014.

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. 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. [1]

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. The company has an approximate 15% market share in specialty drugs. It 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.

CVS is optimistic that it can continue to gain specialty pharmacy share, as it focuses on developing innovative offerings that capitalize on the company’s unique ability to optimize cost, quality and access.

CVS To Benefit From The Increasing Coverage Enrollment Due to the ACA & Medicaid Extension

Total prescription revenue earned by U.S. drugstores are expected to reach $350 billion by the end of 2015, growing at 5.3% annually. [2] The Affordable Care Act (ACA) and the Medicaid expansion is expected to extend health coverage to more than 30 million uninsured Americans. CVS claims that several million Americans have gained coverage in recent months which will provide a positive secular trend in pharmacy volume growth for the next several years.

In its Q2 2014 earnings call, CVS mentioned that approximately 8 million individuals have enrolled in the public exchanges. The mix of individuals who were newly insured, as opposed to those who previously had coverage, still remains unclear, with various sources quoting anywhere from 27% of individuals newly insured to as high as 85%, with multiple data points suggesting it might be somewhere in between. With respect to Medicaid, the available data indicates that 6.7 million individuals have gained coverage, up from 3 million in Q1 2014. [3]

We expect CVS Caremark’s share of retail prescriptions filled in US to reach 25% over our forecast period.


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Notes:
  1. CVS Caremark’s CEO Discusses Q1 2014 Results – Earnings Call Transcript, Seeking Alpha, May 2, 2014 []
  2. New Study Predicts $350 Billion U.S. Pharmacy Industry by 2015, Identifies Risks to Profitability, Pembroke Consulting, July 30, 2013 []
  3. CVS Caremark’s (CVS) CEO Larry Merlo on Q2 2014 Results – Earnings Call Transcript, Seeking Alpha, August 5, 2014 []