While CVS Performs Well In Q3, The Company Seems To Be Gearing Up With New Services To Challenge Competitors

by Trefis Team
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CVS, (NYSE: CVS), the second largest drugstore chain in the U.S., released its Q3 2017 results on November 6th. The company’s earnings beat market expectations after being boosted by its pharmacy benefit management (PBM) business, which overshadowed its weak performance in the retail business. A PBM is a third party that negotiates drug prices on behalf of insurance companies. During its Q3 earnings call, the company announced its intentions to start a next-day delivery service from early 2018, a move that might be triggered by Amazon’s expected entry into the pharmacy business soon. For the third quarter, CVS’ revenues witnessed a 3.5% increase to reach $46.2 billion while its net income declined by ~17% to $1.3 billion. In September, CVS announced its plans of introducing vending kiosks in areas that experience high traffic, such as airports, college campuses, bus terminals etc, so that busy customers have the convenience of accessing its products through these outlets. Last month, the Wall Street Journal reported that CVS has proposed to buy Aetna, the third-largest insurer in the United States, for $66 billion. Both the parties have refused to confirm the existence of the deal as of now. If this deal is a success, CVS will enter a new segment in the healthcare business and it will also have access to Aetna’s ~45 million subscribers. This might be CVS’ way of penetrating further into the healthcare segment as pressure keeps building on the retail sales side.  CVS has been increasingly trying to expand its presence into the healthcare business which began with its 2007 acquisition of Caremark pharmacy benefit manager (PBM) platform. We have an $80 price estimate for CVS Health’s stock, which is around 17% higher than the current market price.

Segment-Wise Performance
The pharmacy services revenues grew by 8.1% y-o-y to $32.9 billion driven by the rise in pharmacy network claims, brand inflation, and growth in specialty pharmacy. The segment includes the pharmacy benefits manager business and specialty pharmacy services. Though its  retail/LTC segment revenues declined by 2.7% to $19.6 billion, however, the performance was better than expected due to better than expected pharmacy same store sales. In 2016, the company lost contracts with the Department of Defense and Prime Therapeutics to its rival Walgreens. The new deals came into effect in December 1, 2016 and January 1, 2017, respectively, and is slowing down 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. These measures are expected to bring savings to the tune of $3 billion by the end of 2021.

The Same Day Delivery Option Might Significantly Help Boost Retail Sales

CVS currently has around 9,703 retail locations with pharmacies. It expects to start its free, same-day deliveries in December from Manhattan and will eventually expand the service across the nation to cities like Miami, Boston, Washington D.C., and Philadelphia by early next year. Drugstores and pharmacy retailers are currently gearing up their customer services in the anticipation of Amazon’s possible entry into the business. Amazon Prime already has same day delivery services for select cities through which it also delivers consumer goods that are available in drugstores. This puts the store chains built by CVS under pressure and hence, CVS’ new service might help in boosting its sales to a significant extent. The delivery service will be speedier than CVS’ mail-order service.

 CVS’ Business Might Receive A Major Boost If Its Alleged Deal With Aetna Works Out

In the event that CVS acquires Aetna, its PBM business will be performing even better due to its greater negotiating powers with the drug companies. The company will 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 the behalf of insurance companies, MinuteClinics, home infusion services, and long-term care pharmacies. While the threat of Amazon’s possible entry into the pharmacy business is eroding the stock values of existing players in the market, CVS’s deal with Aetna might present the pharmacy retailer with major advantages over its peers. This deal might also make up for CVS’s recent loss of some contracts.

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