Note: This report contains substantially new information. Subsequent reports will have changes highlighted.
Reason for Report: 1Q18 Earnings Update
Previous Ed.:Feb 19, 2018; 4Q17 Earning Update
Brokers’ Recommendations: Positive: 73.3% (11 firms); Neutral: 26.7% (4); Negative: 0% (0) Prev. Ed.: 12; 5; 0
Brokers’ Target Price: $86.94 (↓$1.38 from the previous report, 17 firms) Brokers’ Avg. Expected Return: 31.7%
*Note: Though dated May 31, 2018, share price and broker material are as of May 30, 2018.
*Note: A Flash update on ‘1Q18 Earnings’ was done on May 3, 2018.
*Note: We did not get access to any broker report with Neutral rating on the stock
Portfolio Manager Executive Summary
CVS Health Corporation (CVS), headquartered in Woonsocket, Rhode Island and formerly known as CVS Caremark Corporation, is a leading pharmacy innovation company that aims at managing health in an affordable and effective manner. The company currently has 7,900 retail drugstores and more than 1,000 walk-in medical clinics.
Of the 15firms covering the stock, 11(73.3%) rendered positive ratings while four (26.7%) provided neutral ratings. None of the firms have provided a negative rating on the company.
Positive or equivalent outlook (11/15firms): CVS Health’s 1Q18 revenues and adjusted earnings per share (EPS) surpassed expectations of most of the bullish firms as well as that of the market.The firms with a positive stance believe that the better-than-expected results were driven by lower tax rates and interest expenses. They are also of the opinion that the rise in operating profits on improved performance by the Retail/LTC business has contributed to earnings. Also, the firms believe that CVS Health has made solid progress with respect to prescription volumes and cash flow generation. The firms believe that the company’s recent growth strategies in both PBM (through the partnership with Optum) and Retail (by changing store format, implementing online/mobile healthcare and introducing store brands) segments should drive performance in FY18. Also, the firms are upbeat about the company’s successful Transform Value program in diabetes and expect more such programs in oncology, obesity and respiratory categories. These firms also believe that such programs will prove beneficial in 2018. They are upbeat about the various initiatives that CVS Health is adopting to expand the customer base. These new programs include next-day and same-day delivery and automatic refills of prescriptions with a text message. The firms are also impressed with CVS Health’s progress with regard to enterprise streamlining efforts which are expected to generate significant gross benefits in FY18.
Meanwhile, some firms are upbeat about the company’s investment strategy to invest net tax benefits from the U.S. tax reform in the development of employees and technology. The bullish firms are however not satisfied with the 2Q18 PBM guidance as it lags their expectations. They believe that the PBM division will have to incur higher costs owing to the Anthem contract. However, these firms are upbeat about the Aetna acquisition deal, which management says is progressing well. Per the firms with a positive stance, the deal will enhance cost efficiency and quality of health care in the United States.
May 31, 2018
Overview
Based in Woonsocket, RI, CVS Health Corporation (CVS), the nation's premier integrated pharmacy services provider, was renamed in Sep 2014 when the previously known CVS Caremark Corporation changed its corporate name to CVS Health Corporation in an attempt to reflect its broader healthcare commitment. On Sep 3, 2014, CVS Caremark Corporation reported that it is changing its corporate name to CVS Health to reflect its broader health care commitment and its expertise in driving the innovations needed to shape the future of health. Earlier in Mar 2007, CVS Caremark Corporation was formed through a merger betweenCVS Corporation and Caremark Rx, Inc. The company operates in two business segments: Retail/LTC and Pharmacy Services. The Retail/LTC segment sells prescription drugs and general merchandise (front store products), which include over-the-counter (OTC) drugs, greeting cards, film and photo finishing services, beauty and cosmetic products, and convenience foods through the company’s stores, as well as through CVS.com (the company’s online store). The company’s Pharmacy Services business provides a full range of PBM services including mail order pharmacy services, specialty pharmacy services, plan design and administration, formulary management and claims processing. The specialty pharmacies (including mail order and retail specialty pharmacy) support individuals who require complex and expensive drug therapies. The company’s website is
Key investment considerations as identified by the firms are as follows:
Key Positive Arguments / Key Negative ArgumentsThe firms believe that the company should benefit from the integrated PBM-retail pharmacy model and gain traction in the marketplace over time. / Some firms believe that lower-margin PBM business may impede bottom-line growth.
Firms believe that the company is well positioned to benefit from changing market dynamics, including healthcare reform and accountable care organizations in the long-run. / Reimbursement pressure continues to be a headwind for the company.
In the long term, the retail segment of the company is expected to generate strong growth especially with increased access to maintenance choice programs. Moreover, gradual generic introductions are expected to add to the company’s retail sales growth. / The firms believe that each of CVS Health’s retail pharmacy, long-term care pharmacy, retail health clinic and pharmacy services operations currently operates in a highly competitive and evolving health care environment.
Note: The company operates on a calendar-year basis.
May 31, 2018
Long-Term Growth
Retail pharmacies continue to enjoy growth attributable to the aging American population and the increased use of prescription drugs.CVS Health has a strong generic pipeline and should gain from several new drugs that are expected to hit the market in due course. Generic drug usage, as a percentage of total prescriptions, is increasing and CVS Health makes higher profits from selling generic rather than brand-name drugs.
Domestic demographic trends are expected to drive utilization rates in the years to come, as population ages further. Thus, retail pharmacy operators like CVS Health should be able to grow and capture market share. CVS Health has initiated steps to make prescription drugs more affordable to consumers. Currently, management is pursuing opportunities across the continuum of care to drive long-term enterprise value for CVS Health. In view of this, the company is developing an enhanced offering for skilled nursing, which should lead to better outcomes for patients, providers and payers. It is also developing segmented assisted-living offerings to provide improved care to residents with varying needs. Moreover, the company is targeting the rapidly growing independent living market.
Management is also highly optimistic about the company’s acquisitions – Omnicare and pharmacy business of Target – both of which are expected to enhance CVS Health’s long-term growth. While the acquisition of Target’s pharmacies and clinics expanded CVS Health’s core business, the Omnicare buyout enhanced its reach in long-term care pharmacy space. In the context of the Omnicare takeover, management is currently combining operational infrastructures and developing programs to improve work streams and enhance delivery service, over the near as well as the long term. With respect to the Target pharmacy buyout, management plans to provide unique offers to Target guests, who don’t use CVS pharmacy, to participate in unique cost-saving CVS programs like Maintenance Choice, Specialty Connect etc. The 79 Target clinic locations that CVS Health acquired will be rebranded as MinuteClinic and management expects to open up to 20 new clinics in Target stores within 2018. So with CVS systems and branding now in place, the company is working on its patient care programs, along with its marketing and member engagement campaigns that are expected to increase awareness and utilization of CVS at Target.
On its Analyst Day, held in FY16, CVS Health discussed its strategy to establish itself as a distinguished enterprise in the evolving healthcare market, over the long term. The company aims at maximizing its long-term shareholder value by generating significant free cash flow and optimizing capital allocation. Its primary focus also revolves around expanding its core pharmacy business and extending its reach to new healthcare channels. Going ahead, CVS Health plans to introduce innovative products and make long-term value enhancing investments; thereby manifesting its leadership in multiple competencies to drive superior values for its healthcare partners.
May 31, 2018
Target Price/Valuation
Rating DistributionPositive / 73.3%↑
Neutral / 26.7%↓
Negative / 0.00%
Avg. Target Price / $86.94↓
Maximum Target / $100.00
Minimum Target / $73.00
No. of Analysts with Target price / 17
Upside from current / 31.7%
Maximum Upside from current / 51.7%
Minimum Upside from current / 4.4%
Risks to target price include lower-than-expected PBM new contract wins, an anticipated PBM price war, reduced drugstore same-store sales or margins, competitive pressures in the PBM industry, the loss of one or more key customer accounts, delays in generic drug introductions, the inability of CVS to grow its list of PBM clients, a loss of retail pharmacy market share to competitors, increased industry regulation and changes in the existing health care law.
Recent Events
On May2, 2018, CVS Health reported 1Q18 results. Highlights are as follows:
CVS Health reported 1Q18 adjusted EPS of $1.48, up26.5% year over year (y/y).
Net revenues in 1Q18 increased 2.6% y/y to $45.69 billion.
CVS Health currently expects FY18 adjusted EPS in the band of $6.87 to $7.08. The company has also provided guidance for 2Q18. CVS Health estimates adjusted EPS in the band of $1.59 to $1.64.
Revenues
Net revenues in 1Q18 increased 2.6% y/y to $45.69 billion, primarily ongrowth in specialty pharmacy volumes, higher pharmacy network volumes as well as brand inflation. This was, however, partially offset by increased generic dispensing and continued price compression.
Revenues by Segment
The company operates in two business segments: Retail/LTC and Pharmacy Services.
Retail/LTC Segment
The Retail/LTC segment sells prescription drugs and general merchandise (front store products), which include over-the-counter (OTC) drugs, beauty products and cosmetics, photo finishing, seasonal merchandise, greeting cards and convenience foods. These are sold through the company’s retail stores (including pharmacies located within the Target stores), as well as through CVS.com and Onofre.com.br (the company’s online retail pharmacy websites), 32 onsite pharmacy stores and also retail health care clinics.
With the takeover of Omnicare, the Retail/LTC Segment now includes Long Term Care (LTC) operations, which are engaged in the distribution of pharmaceuticals, related pharmacy consulting and other ancillary services to chronic care facilities and other care settings, as well as commercialization services which are provided under the RxCrossroads brand. CVS Health added approximately1,670pharmacies through the acquisition of the pharmacies of Target Corporation ("Target") in Dec 2015, thereby expanding presence in new and existing markets. The stores within Target sell only prescription and over-the-counter drugs that are required to be behind the pharmacy counter. The Retail/LTC Segment also operates retail medical clinics under the MinuteClinicname.
As ofMar31, 2018, the Retail/LTC Segment included9,847 retail stores (of which 8,099operated a pharmacy and 1,699 pharmacies were located within Target stores) across49states, the District of Columbia, Puerto Rico and Brazil operating primarily under the CVS Pharmacy, CVS, Long Drugs,Navarro Discount Pharmacyand Drogaria Onofre.
The number of onsite pharmacies primarily operating under CarePlus CVS Pharmacy, CarePlusand CVS Pharmacy is 37. The total number of retail health care clinicsoperating under the MinuteClinicname (of which1,107were located in CVS Pharmacy and Target stores) is 1111. Online retail websites, CVS.com, Navarro.comand Onofre.com.br. LTC operations comprise163spoke pharmacies that primarily handle new prescription orders, of which30are hub pharmacies that use proprietary automation to support spoke pharmacies with refill prescriptions. LTC operates primarily under the Omnicareand NeighborCarebrands.
MinuteClinics utilize nationally recognized medical protocols to diagnose and treat minor health conditions, perform health screenings, monitor chronic conditions and deliver vaccinations. The clinic staff comprises board-certified nurse practitioners and physician assistants who provide access to affordable care without appointment.
Revenues at CVS Health’s Retail/LTC rose5.6% y/y to $20.4 billion primarily on a 5.8% increase in same-store sales and brand inflation, partially offset by continued reimbursement pressure and a rise in the generic dispensing rate.
Per the company, the upside in the Reatil/LTC wing was led by rising script volumes on the back of continued adoption of Patient Care Programs, CVS Health’s position in several Medicare Part D networks and partnerships with PBMs and health plans across the industry.
Front-end same-store sales were up1.6% y/y on a 90-basis point favorable impact of the shift of sales associated with the Easter holiday to 1Q18 from 2Q18. This apart, seasonal cough and cold positively impacted the Front-store sales by another 70 basis points approximately. However, this was adversely affected by soft customer traffic.
However, Store Brands is an area of strength and opportunity for CVS Health. According to management, there are opportunities to expand the share of Store Brand products by focusing on health and beauty.
Pharmacy same-store sales increased7.3% in 1Q18, but was affected by approximately 280 bps owing to recent generic drug introductions. Moreover, Pharmacy same-store prescription volumes increased 8.5% on a 30-day equivalent basis.
The generic dispensing rate (the proportion of all generic prescriptions to total number of prescriptions dispensed) rose 60 bps to 88.1% at the Retail/LTC segment.
Management claims that CVS Health is focused on working with all payers to drive volumes and capture market share in FY18 and beyond. The company’s tie-up with OptumRx to provide a 90-day Pharmacy solution to OptumRx commercial clients was made available beginning in July. CVS Health is also poised to gain from programs such as Health Tag and ExtraCare Health Card. Subsequently, the company is planning to collaborate with PBMs and health plans to offer a menu of services such as MinuteClinic services, Infusion and Long Term Care. Moreover, management aims to join in some more Med D networks, including SilverScript, Aetna and WellCare to stimulate growth in prescription volumes in the Med D market.
Moving on to CVS Pharmacies in Target stores, the company continues to witness improving script performance. Per management, patient care programs and Maintenance Choice continue to drive performance.
Recognizing the growing presence in the digital market, CVS Health has also been focused on enhancing its online and mobile capabilities in FY17. Building on the strength of CVS Health’s digital tools within pharmacy, where 60% of its patients are using them, the company is focused on offering advanced services to its customers. And these services range from Curbside program to same-day delivery options as well as enhanced mobile functionality and ExtraCare. Moreover, CVS Health has been partnering with Instacart and is now delivering from 2,800 stores.
Pharmacy Services
The company’s Pharmacy Services business provides a full range of pharmacy benefit management (PBM) services consisting primarily of employers, insurance companies, unions, government employee groups, health plans, Medicare Part D plans and Managed Medicaid Plans. Additionally, through SilverScriptInsuranceCompanysubsidiary, the company offers drug benefits to eligible beneficiaries under the federal government’s Medicare Part D program.
As of Mar 31, 2018, the Pharmacy Services segment operated 25 retail specialty pharmacy stores, 18 specialty mail order pharmacies, four mail order dispensing pharmacies and 86 branches for infusion and enteral services, including approximately 74 ambulatory infusion suites and three centers of excellence, located in 43states, Puerto Rico and the District of Columbia.
The Pharmacy Services segment’s revenues rose 3.2% to $32.2 billion in 1Q18 on higher specialty pharmacy volumes, increased pharmacy network claim volumes as well as brand inflation. This was partially offset by increased generic dispensing and price compression.
The generic dispensing rate (the proportion of all generic prescriptions to total number of prescriptions dispensed) increased 65 bps to 87.6% y/y at the Pharmacy Services segment.
Pharmacy network claims processed during 1Q18 went up 6.4% to 468.8 million on a 30-day equivalent basis, backed by net new business growth. Moreover, the Mail Choice processed claim count was 69 million, up 5.9% on a 30-day equivalent basis on continued adoption of Maintenance Choice offerings and increase in specialty pharmacy claims.
The programs under Pharmacy Services segment include Patient Care Initiative, an enhanced adherence program; Maintenance Choice, a program where eligible client plan members can elect to fill their maintenance prescriptions at CVS retail pharmacy stores for the same price as mail order; Pharmacy Advisor that facilitates pharmacist counseling, both face-to-face and over the telephone; Specialty Connect, an integrated specialty pharmacy offering which integrates specialty mail and retail capabilities as well as ScriptSync, a service that enables patients with multiple medications to pick up their eligible maintenance prescriptions in a single monthly CVS Pharmacy visit.
Per management, all the aforementioned pharmacy services demonstrate CVS Health’s capacity to enhance the customer experience through its integrated enterprise products and services.