CVS Reports A Solid Q2’15, Pending Acquisitions To Further Accelerate Growth
CVS Health (NYSE:CVS), the largest pharmacy services provider in the U.S., reported its Q2 2015 earnings on August 4th. The company continued its strong growth momentum in Q2 2015, with both revenue and earnings per share (EPS) beating Wall Street expectations. By its own admission, the company’s performance in the first half of 2015 has been better that what it initially expected. CVS believes that the outlook for all its business segments remain strong, and claims that the cadence of profit growth is back half weighted. Additionally, the pending acquisitions of Omnicare and Target’s Pharmacy Stores are expected to give an additional boost to its growth momentum well beyond 2015.
Quick Snapshot of Q2 2015 Earnings
At $37.2 billion, CVS’ Q2 2015 revenue was up 2.3% quarter on quarter and 7.4% year on year. Pharmacy Benefit Management (PBM) revenue increased 11.9% annually, to $24.4 billion, driven primarily by the continued growth of specialty pharmacy and an increase in pharmacy network claims. CVS’ retail segment revenue increased to $17.2 billion, a 2.2% year on year growth, on account of solid pharmacy same-store sales and healthy script growth. At 17.2%, the company’s gross margin declined by 105 basis points year on year, as the lower margin PBM business continued to grow faster than the retail business. CVS’ adjusted earnings per share increased 7.7%, to $1.22, which excludes $0.03 of acquisition-related transaction and financing costs. The company opened 20 net new stores in Q2 2015, and plans to take the number to 150 net new stores by the end of 2015. (CVS Health’s Q2 2015 Earnings Release)
CVS stated that much of the out-performance in Q2 2015 was driven by lower than expected inter-company profit eliminations, due to the mix of the business, as well as a favorable tax rate.
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Pending Acquisitions To Spur Future Growth
CVS announced two acquisitions in Q2 2015: 1) Pharmacy services provider Omnicare for about $10 billion; and, 2) Target’s pharmacies and clinics for $1.9 billion.
The acquisition of Omnicare will help CVS strengthen its position in the PBM and specialty pharmacy markets. Omnicare will equip CVS with a a new pharmacy dispensing channel, enhancing its ability to provide the continuity of care for patients as they transition through the healthcare system. Additionally, Omnicare’s complementary specialty pharmacy platform and clinical expertise will augment CVS’ capabilities in the specialty segment, which is already an important growth driver for the company. (Read: How Will CVS Benefit From its Acquisition of Omnicare?)
The acquisition of Target’s more than 1600 pharmacy stores and 80 medical clinics last month, makes CVS’ network of pharmacies the largest among its competitors. Not only does this move increase CVS’ share of the total prescriptions filled in the U.S., by enabling the company to expand its retail presence in new markets, but it will also yield additional benefits in the form of lower drug acquisition costs, leading to better EBITDA margins. (Read: CVS to Buy All of Targets Pharmacy Stores – A Win-Win For Both)
Both transactions are subject to approval by shareholders as well as other customary closing conditions including regulatory approval. While CVS expects to close the Omnicare transaction by the end of 2015, the timing of the close of the Target transaction is uncertain and could fall into 2015 or 2016.
Specialty Pharmacy Will Continue To Be A Strong Growth Driver
In Q2 2015, CVS’s specialty segment continued to grow faster than the market, with revenues increasing 28.4%. While the growth was more than double the market growth rates, it was less than recent quarters on account of the addition of Coram and a flattening in the utilization trend of the new Hep C drugs. In addition to inflation, the growth in specialty was driven by increased claims due to new products, new clients, and the impact of Specialty Connect. Partially offsetting this growth was an increase in the generic dispensing rate, which grew approximately 150 basis points year on year. CVS’ specialty pharmacy suite of services continued to gain share in Q2 2015.
CVS has developed a comprehensive set of programs to effectively manage specialty trend, the leading formulary exclusion strategy in an example. It intends to employ similar strategies to manage PCSK9 inhibitors, the new class of cholesterol-lowering agents. The company claims that the potential market for PCSK9 is larger than any specialty product available today. The PCSK9 market could be worth $10 billion a year, according to FiercePharma. [1]
Specialty drugs treat complex diseases such as multiple sclerosis, rheumatoid arthritis, hepatitis C and cancer, among others. Because of the specialized way in which these drugs need to be administered, specialty pharmacies play an important role in providing the support required to effectively deliver these drugs to patients. CVS’ Specialty Connect offering, which was rolled out by May 2014, fills this need for greater convenience and access to specialty medications. According to a Drug Channel Institute report, in 2018, six of the ten best-selling drugs by revenue are projected to be specialty drugs, compared with three drugs in 2010 and five in 2012.
Q3 2015 Guidance
– Retail segment revenue to increase 2.75% to 4.25% year on year. Adjusted script comps are expected to increase in the range of 4.75% to 5.75%, while total same-store sales is expected to be up 1.0% to 2.5%.
– PBM revenue growth between 9.0% and 10.25%.
– Retail operating profit to increase 4% to 6% and PBM operating profit to increase 2% to 6%.
– GAAP and adjusted EPS in the range of $1.13 to $1.16 and $1.27 to $1.30, respectively.
Fiscal 2015 Outlook
– Net revenue growth of 7.5% to 8.5%. PBM and retail segment revenue growth of 11.5% to 12.5% and 2.5% to 3.25% year on year, respectively.
– PBM and retail operating profit to increase 10% to 12% and 4.25% to 5.5%, respectively.
– Free cash flow in the range of $5.9 billion to $6.2 billion, excluding the impact of acquisition-related costs.
– Adjusted EPS of $5.11 to $5.18, excluding acquisition-related transaction and financing costs.
– GAAP diluted EPS in the range of $4.64 to $4.71.
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