CVS Meets Expectations Despite Headwinds. Management Confident of Carrying Momentum Into 2015.

On Tuesday February 10th, CVS Health (NYSE:CVS) announced its quarterly earnings for the final quarter of 2014, ending December 31, 2014. This fiscal year, CVS consistently posted solid financial results and the fourth quarter was no exception. The company’s PBM business continued growing (up 22% year over year), driven by specialty pharmacy revenues, and helped counter a sales decline caused by the company’s decision to exit tobacco last year. Its retail business also posted strong growth in same-store sales (up 5.5% year over year), despite the transfer of specialty scripts from the retail segment to the PBM segment (Specialty Connect program). Moving towards the bottom line, the gross and operating margins declined 140 bps and 50 bps respectively. But, these declines didn’t bring any surprise as they are within the company’s expectations.

As CVS successfully achieved results at the high-end of their earnings guidance range and most of the expected negative impacts stayed within expectations, the management remains confident of continuing the performance in 2015. On this note, the company reconfirmed the 2015 earnings guidance that they provided during the 2014 analyst day meet held in December.

Our price estimate of $80 for CVS Health is approximately 20% below the current market price. We are in the process of updating our model for the company. Meanwhile, in the below article, we talk about the implications of a few key trends the company’s management highlighted during the earnings call.

View our detailed analysis for CVS Caremark

Specialty Connect Playing a Critical Role in PBM Business Expansion

In the last fiscal year, CVS’ PBM business generated $7 billion in new business encompassing about 150 new clients serving millions of new members. A critical factor contributing to the continued growth of this segment is the way CVS is able to address unmet needs of its PBM clients, physicians and patients in general.

CEO, Larry Merlo says that the number one priority center for their clients is to control the rapidly rising specialty costs. The company addresses this issue through proactive formulary management, which provides clients with a lot of flexibility in terms of the programs available that meet their priorities, as they differ from patient to patient. On the other hand, a key challenge for patients is to navigate the logistics involved in receiving drugs. The Specialty Connect offering, which was rolled out by May 2014, fills this need for greater convenience and access to specialty medications. Through this program, patients can choose to pick up their specialty medications at their local CVS pharmacy or have them mailed to their homes from CVS’ specialty mail order pharmacies. Given the temperature-sensitive nature of many of these products (specialty therapies), allowing patients the choice of picking them up at their local CVS/pharmacy means that they no longer have to wait at home for delivery to ensure the integrity of their medications. Also, physicians appreciate the ease of getting their patients started on therapy resulting from the reduction in barriers.

Tobacco Exit – Positives and Negatives

CVS’ stores have been tobacco free since September 2014, which the company has been expecting to negatively impact their retail business. Though the most heavily impacted categories are consistent with the company’s expectations, the magnitude of the impact on those categories has been a bit less than expected. Front store comps were down 7.2% and adjusting for the tobacco impact, front store comps would have been up 0.7%. The impact of the tobacco exit was about 800 basis points, which is about 100 basis points less than what was anticipated. While it is too early to conclude on the decision’s impact on sales, the management is pleased with the results so far.

Surprisingly, there have also been a few positives arising out of this move. Front store margins have benefited this quarter as the company started reaping the benefits of its investments in promoting store brand sales. It made great progress in store brand penetration with store brands increasing to 22% in front store sales, up 310 bps from Q4 of last year. While about 190 basis points of this improvement reflects the removal of tobacco from the product mix, the other 120 basis point reflects underlying progress in store brand penetration, with gains seen across health, beauty, general merchandise and edibles. This has also increased brand awareness, as a ~1,100 basis point increase was seen in the awareness of the CVS Health brand among consumers. Helena Foulkes, the EVP and President of the pharmacy division, said that the company would use this momentum to focus on health and beauty and position themselves as a leading health and beauty destination.

Q1 2015 Outlook

– Adjusted EPS of $1.06 to $1.09

– GAAP diluted EPS from continuing operations of $0.99 to $1.02

2015 Annual Outlook

– Adjusted EPS in the range of $5.05 to $5.19, up 12.5% to 15.75% (excluding the loss on early extinguishment of debt in 2014)

– GAAP diluted EPS from continuing operation in the range of $4.77 to $4.91.

– Free cash flow between $5.9 billion to $6.2 billion.

– Cash from operations between $7.6 billion and $7.9 billion.

– Share repurchase of approximately $6 billion.

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Sources:

• CVS Health Q4 2014 Results – Seeking Alpha Earnings Call Transcript
• CVS Health Investor Resources