CVS Is in Good Health - Barron's

With a healthy-retail business and plenty of upside potential, Barron's Lawrence C. Strauss explains why CVS Caremark (CVS) could trade in the 40s within a year vs. a recent $35.72.

CVS is the country's leading retail pharmacy chain. Its 6,900 drug stores reported strong Q2 results, and CVS is initiating programs like its 'Maintenance Choice' to attract more customers. CEO Tom Ryan expects next year's profits to grow by 13-15%.

Its pharmacy-benefit management [PBM] unit is showing signs of improvement and will further benefit from a wave of drugs that are about to go generic, raising CVS' profit margins. On the downside, operating margins fell at the PBM unit in the most recent quarter and it's not expected to gain marketshare anytime soon (though it already holds an impressive 17.5% share, just shy of industry leader Medco Health Solutions' (MHS) 17.8%). In the meantime, CVS continues to benefit from increased synergies between the PBM unit and its retail network. The combination has led to around $700M in annual savings.

When it comes to health care reform, CVS doesn't stand to either gain or lose very much. While greater health coverage for U.S. citizens could mean more business for CVS, profits could also be hurt by reimbursement policies.

CVS' recent acquisition of regional chain Longs Drugs "will be probably less dilutive this year than we originally thought" according to Ryan. The chain's stores also offer good upside because they were less efficient than CVS outlets. CVS remains open to further acquisitions and also plans to open or relocate 250-300 stores this year.

CVS' shares trade at 11.6 times next year's profit estimates, a comparatively cheap valuation next to rivals Walgreen (WAG), Medco Health Solutions and Express Scripts (ESRX). It has a solid balance sheet, with $11B in debt as of June 30 and $1.23B in cash and equivalents. The firm is buying back $2B of stock this year and its annual dividend of $0.305 has grown at a compound annual rate of 18% over the past five years.

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• CVS Caremark: Q2 EPS of $0.65 beats by $0.01. Revenue of $25B (+18%) vs. $24B. (PR)
• Aetna (AET) is reportedly looking to sell its pharmacy benefits management business for up to $2B, and CVS is among the potential buyers, as is Medco Health Solutions.
• In April, Express Scripts agreed to buy WellPoint's (WLP) in-house pharmacy-benefit management business for $4.68B in a move that will make it a stronger competitor against larger rival CVS.

Comments

[satyr:]

Not mentioned here is the fact that the feds are taking a hard look at the CVS/Caremark combination on complaints that the outcome has been anti-competitive. It seems unlikely that they would unwind the combination, but they could certainly cause some grief. A possible outcome is that they could be forced to build a firewall between the to parts of the organization, which would take from the "synergies", and limit the PBM's side from forcing customers to their captive pharmacy, as well as their ability to direct market to insurance customers who use competing retail outlets. It remains to be seen if this combination model will prove the most successful. If it does, I would expect that over time Walgreens will merge with ExpressScripts and Medco will purchase Rite Aid.

Aug 24 11:08 PM

[satyr:]

Looks like something rose to the surface for CVS, and it wasn't cream.

Nov 06 03:48 AM