VALUATION HIGHLIGHTS

1. Prescription Drugs constitute 34% of the Trefis price estimate for CVS Health's stock.
2. Health Care Benefits constitute 34% of the Trefis price estimate for CVS Health's stock.
3. OTC Drugs & Other constitutes 33% of the Trefis price estimate for CVS Health's stock.

WHAT HAS CHANGED?

1. CVS Stock Performance

CVS stock has seen little change, moving slightly from levels of $70 in early January 2021 to around $75 now (early March 2024), vs. an increase of about 35% for the S&P 500 over this roughly 3-year period.

Overall, the performance of CVS stock with respect to the index has been quite volatile. Returns for the stock were 51% in 2021, -10% in 2022, and -15% in 2023.

2. Q4 2023 Performance

CVS Health posted better-than-expected Q4 results with revenues of $93.8 billion, up 11.9% y-o-y, led by growth across all segments. The company's adjusted EPS of $2.12 was up 4% from $2.04 in the prior-year quarter. Looking forward, the company expects 2024 full-year EPS to be between $8.30 and $8.50.

3. Impact of Covid-19

CVS Health saw an increase in government-sponsored healthcare plan enrollments amid higher unemployment during the pandemic. Additionally, given the healthcare institutions' focus on Covid-19 and other emergency treatments, several types of elective surgeries were postponed in 2020, resulting in a lower MBR ratio (Benefit Costs as % of Premium Revenue) declining to 81% in 2020, compared to 84% in 2019. This also aided the company's 2020 earnings, which grew 6% to $7.50 per share on an adjusted basis, compared to $7.08 in 2019. However, 2021 marked recovery, and its vaccine administration helped its earnings rise 12% to $8.40. MBR stood at 84% in 2022, and its adjusted earnings per share grew 3% to $8.69.

4. Aetna Acquisition

The Company acquired 100% of the outstanding shares and voting interests of Aetna for a combination of cash and stock in November 2018. Under the terms of the merger agreement, Aetna shareholders received $145 in cash and 0.8378 CVS Health shares for each Aetna share. The transaction valued Aetna at approximately $212 per share or approximately $70 billion. Including the assumption of Aetna's debt, the total value of the transaction was approximately $78 billion. The Company financed the cash portion of the purchase price through a combination of cash on hand and by issuing approximately $45 billion of new debt, including senior notes and term loans. Aetna is a health care benefits company that offers traditional, voluntary, and consumer-directed health insurance products and related services. The acquisition of Aetna should improve the consumer health care experience for the company as they will combine Aetna's health care benefits products and services with CVS Health's more than 9,900 retail locations, approximately 1,100 walk-in medical clinics, and integrated pharmacy capabilities.

5. CVS And Its Several Partnerships To Improve Its Performance

The company has undertaken certain steps to ensure a better growth trajectory in the future. It is focusing on partnering with all payers to boost volumes and capture market share. A partnership with Cigna Health Works was announced in 2017. It has also partnered with Express Scripts' Diabetes Care Value program to be its retail network option. The company is in talks with many such PBM health plans to expand the reach of its network.

CVS Health made another big deal that has helped it grow its business significantly. Completed in 2018, the $70 billion acquisition of Aetna by CVS has provided a major boost to CVS's business. The combination has provided consumers with a more integrated experience, reduced costs, and improved access to healthcare. This will combine CVS's dense local presence through pharmacies and clinics with Aetna's health care benefits and services.

CVS's PBM business has gotten greater negotiating power with drug companies. The company will also be able to tap into Aetna's 45 million user base and provide them with its offerings, which include pharmacy benefit management – the negotiation of drug prices on behalf of insurance companies - MinuteClinics, home infusion services, and long-term care pharmacies.

In March 2023, CVS completed its planned acquisition of Signify Health, a home healthcare services provider, in an $8 billion deal. In May 2023, it acquired Oak Street Health for $10.6 billion.

POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE

Prescription Drugs

Prescription Drugs EBITDA Margin: We currently forecast CVS Health's EBITDA margin for prescription drugs to rise from 3% in 2022 to over 7% by the end of our review period. There could be a 20% upside to the Trefis price estimate if margins improve to 10% by the end of our forecast period.

Pharmacy Benefit Management

PBM EBITDA Margin: We currently forecast EBITDA margins for pharmacy services to rise from 2.4% in 2022 to about 5% by the end of our review period. There could be an upside of over 20% to the Trefis price estimate if margins were to increase to over 7% over our review period. On the other hand, there will be a similar downside if margins come under pressure due to the acquisition of new contracts and other contract renewals.

Capital Expenditure: We currently forecast capital expenditures as a percentage of EBITDA to fall slightly to about 20% over our forecast period. There could be an approximate 10% downside to the Trefis price estimate if this figure were to rise to the level of close to 25% by the end of our forecast period.

BUSINESS SUMMARY

CVS Health (NYSE: CVS) is the largest pharmacy services provider in the US, comprising the largest network of retail pharmacy stores nationwide along with pharmacy services such as mail-order pharmacy services, prescription plan management, and claims processing. CVS fills and manages over 1 billion prescriptions per year through its businesses.

Currently, CVS operates over 9,000 Pharmacy stores. The retail business provides health care services through more than 1,100 retail health clinics and MinuteClinics, which are mostly located inside CVS pharmacies and serve to diagnose and treat minor health issues. The retail pharmacy business also includes an online pharmacy, CVS.com.

CVS retail stores sell prescription drugs and a wide assortment of general merchandise, including over-the-counter (OTC) drugs, beauty products, cosmetics, photo finishing, seasonal merchandise, greeting cards, and convenience foods.

In March 2007, CVS merged with Caremark Rx, which brought together the nation's largest retail pharmacy chain and a leading pharmacy benefit manager. CVS Health's Pharmacy Services business provides a full range of pharmacy benefit management (PBM) services, including mail-order pharmacy services, specialty pharmacy services, plan design and administration, as well as formulary management and claims processing services. The company's customers are primarily employers, insurance companies, unions, government employee groups, managed care organizations and other sponsors of health benefit plans and individuals throughout the US.

In August 2015, CVS acquired Omnicare and broadened the base of pharmacy care to a new dispensing channel, a long-term care pharmacy. Omnicare's long-term care (“LTC”) operations include the distribution of pharmaceuticals, related pharmacy consulting, and other ancillary services to chronic care facilities and other care settings. Omnicare also provides commercialization services under the name RxCrossroads.

In December 2015, CVS acquired Target Pharmacies for approximately $1.9 billion. CVS acquired Target's 1,672 pharmacies which operate in 47 states and operates them through a store-within-a-store format, branded as CVS Pharmacy. The Company also acquired 79 Target clinic locations. The Company acquired the Target pharmacy and clinic businesses primarily to expand the geographic reach of its retail pharmacy business.

In 2016, the company lost contracts with the Department of Defense and Prime Therapeutics to its rival Walgreens. This weighed on CVS' performance in 2017. The company took several measures to counter the loss of contracts, including the expansion of its ongoing partnership with Optum and the offer of bundled service offerings to its customers. It plans to improve its productivity by focusing on store rationalization and optimizing its delivery platform.

The company has undertaken certain steps to ensure a better growth trajectory in the future. It is focusing on partnering with all payers to boost volumes and capture market share. For example, it partnered with Optum to provide 90-day retail solutions to the latter's ASO clients. In November 2018, CVS acquired Aetna for $70 billion, giving it access to the healthcare benefits and services market.

As a pharmacy benefits manager, CVS Health manages the dispensing of pharmaceuticals through its fully automated mail-order pharmacies and national network of approximately thousands of retail pharmacies to eligible members in the benefit plans maintained by its clients. It utilizes proprietary information systems to perform safety checks, drug interaction screenings, and brand-to-generic substitutions.

SOURCES OF VALUE

Prescription Drug Sales, Healthcare Services, and Pharmacy Services are major sources of value for CVS Health, each accounting for a little over 30% to CVS' total value

The accessibility of stores and convenient shopping experiences make CVS an attractive destination for consumers.

CVS has a large network of strategically located retail drugstores across the US. It has over 9,000 pharmacy locations, and around 75% of the U.S. population lives within a three-mile radius of a CVS store, lower than any of the other drugstore chains in the U.S. (Walgreens claims to have 75% population within a five-mile radius). This makes CVS stores more accessible to a larger number of consumers than other pharmacies.

CVS employs over 30,000 pharmacists, nurse practitioners, and physician assistants (more than Walgreens' number of 17,000) who are responsible for interfacing with patients, advising customers and providing them more personalized attention as compared to other retail pharmacy chains.

CVS has about 1,135 in-store MinuteClinics across 28 states, making it easy to get treatment for common ailments, receiving vaccinations or obtaining health screenings. More than 70% of CVS stores are either open round-the-clock or offer extended hours, and over 60% have drive-thru windows, offering greater convenience to customers.

Pharmacy Benefit Management is a major source of value for CVS Haelth, accounting for almost 40% of its total value

CVS's business strategy centers on providing innovative pharmaceutical solutions and quality client service in order to enhance clinical outcomes for its clients' health benefit plan members, while assisting its clients and their plan members in better managing overall health care costs. In addition, as a fully integrated pharmacy services company, CVS Health is able to offer its clients and their plan members a variety of programs and plan designs that benefit from its integrated information systems and the ability of its more than 34,000 pharmacists, nurse practitioners and physician assistants to interact personally with the plan members.

CVS Health's clients are primarily sponsors of health benefit plans (employers, insurance companies, unions, government employee groups and MCOs) and individuals located throughout the U.S.

KEY TRENDS

Increasing demand and utilization of prescription drugs in the U.S.

An aging population combined with the fact that older people contribute to a larger proportion of expenditures on drugs will lead to an increase in the prescription drugs market size.

Looking at demographics, the number of people in the United States who are 65 or older was roughly 54 million in 2019 and the figure is expected to grow to 81 million in 2040. This age group fills an average of more than 25 prescriptions per person annually – 30% more than people between the ages of 55 and 64. That will increase utilization dramatically for years to come and will help drive the growth of both - PBM and retail businesses.

Accelerating sales of generic drugs and private label goods to positively impact gross profit margins of retail stores.

Generic drugs offer a significantly higher gross margin compared to branded drugs. The total generic dispensing rate, which factors the percentage of generic drugs in a consumer's prescription, grew to around 87% in 2022, compared to 81% ten years ago. Generic drugs continue to replace branded drugs, albeit at a slower pace. With the expansion of generic drug sales in the U.S. (even if the pace is expected to slow down), the company may have room for growth in EBIT margins.

Private labels have grown increasingly popular among US consumers as they offer the same quality as established brands and are priced lower. This offers customers value while providing CVS with significantly higher margins.