CVS Starts Fiscal On A High Note, PBM Will Continue To Boost Revenues

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At the end of last week, CVS Health (NYSE:CVS) announced its quarterly earnings for the three months ended March 31, 2015. As expected, the company’s PBM business continued to drive growth with significant contributions from specialty pharmacy and pharmacy network claims. Overall, revenues in the pharmacy services segment increased by 18.2% to $23.9 billion. On the other hand, revenues in the retail pharmacy segment increased by 2.9% to $17.0 billion. Pharmacy same-store volumes increased 5.1% (sales increased 4.2%) as the company continued to gain pharmacy share. CVS’s share in the retail pharmacy market stood at 21.5%, an increase of 50 basis points versus the same quarter a year ago. The company reported 17% in gross margins, which is a contraction of about 120 basis points year-over-year. As the PBM  business offers lower margins compared to the retail business, higher top line growth in the PBM segment led to lower overall margins.

Overall, it was a better-than-expected first quarter for CVS. In this article, we will look at why the company is confident of continuing the growth momentum. We have a price estimate of $81 for CVS Health, which is at a discount of approximately 20% to the current market price.

View our detailed analysis for CVS Health

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Specialty Pharmacy To Continue To Be The Star Performer

Specialty revenues continued on a strong growth trajectory in the quarter increasing 46% year over year. While new specialty therapies have hit the market frequently, 88 drugs in the last 3 years, existing ones received more than a 100 new indications during the same time period [1]. 2014 saw the launch of new specialty drugs for Hepatitis C, Sovaldi and Harvoni, which cost $84,000 and $94,500 respectively for a 12-week course of treatment. The fact that these drugs accounted only for 10% of the overall revenue growth indicates how strong the growth of the drug group, as a whole, is.

This year, a new class of drugs called PCSK9 inhibitors, which lower cholesterol, are expected to be launched. While it might take a while for the new class of drugs to be adopted, partially because of the significant step-up in cost compared to currently used generics, the potential it holds is enormous. The company said that one in four people that are on stance currently could be candidates for these new therapies. In all, the PCSK9 market could be worth $10 billion a year, according to FiercePharma [2]. Note that CVS reports its specialty revenues as part of its PBM business, unlike earlier when it was included in the retail pharmacy segment.

New Client Additions And Renewals To Increase Number Of Scripts Processed

After the impressive first quarter, especially in the PBM business, CVS narrowed its 2015 top-line outlook for its services segment to growth between 11.25% and 12.25%, 25 basis points higher than the prior guidance range on the low-end. Even the operating profit guidance for the division has been narrowed down to between 7.75% and 10.75% year-over-year, an increase of 100 basis points on the low end. While some of these revisions reflect expectations from growth in specialty revenues, new additions to the PBM business is also a key contributor.

For the 2015 selling season, net new business stands at $4.1 billion, about $0.5 billion higher than what the company expected during its last update. On the other hand, it has also completed about a third of client renewals for the 2016 selling season. Credit for this growth goes to the company’s services, which have been able to generate significant savings for its clients. CVS’ formulary management solution promotes lower cost generics and provides limited access to branded drugs by constantly changing the drugs listed on its formulary. Compared to a 12.7% growth trend in the overall book of business, its clients using the value formulary achieved a growth trend of only 0.5%, more than 1200 basis points better than the overall book. In times when drug expenses are hitting new highs, we believe that services offering such significant cost savings will continue to attract new clients.

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Notes:
  1. Seeking Alpha Earnings Call Transcript CVS Q1 2015 []
  2. Payers fret about the next drug doomsday: Pricey PCSK9 cholesterol meds []