CVS Caremark Tumbles on Lost Business

Pharmacy operator CVS Caremark (CVS) shares stumbled down more than 20% on Thursday morning after they reported earnings. The earnings themselves were just about what the street had expected with profit from continuing operations coming in at $.65 per share, besting estimates by one penny. However, the company revealed that their Caremark pharmacy benefits management unit lost $2 billion in business in the period. The lost contracts include such as large deals with New Jersey state Blue Cross plan and Ohio’s managed Medicare. Contracts such as these are a major loss for shareholders as they represent a steady stream of reliable income that adds to the stability of the pharmacy business. The President of the Caremark unit will step down and his responsibilities will temporarily be assumed by CEO Tom Ryan.

The quarter was otherwise pretty decent for CVS with revenue rising 18% to $24.64 billion, which was on pace with analysts’ expectations. Revenue at drug stores increased 17.9% which was aided by a 10% increase in flu related prescriptions, which the company expects to remain strong through the fourth quarter. Furthermore, same store sales were impressive, growing at a 5.7% rate. Net income was up 39% to $1.02 billion or $.72 per share, but there was also a reported eleven cent tax benefit. Management was prompted to lift the lower end of its full year earnings guidance range by two cents per share to $2.61 to $2.64.

The loss of these valuable contracts really put a damper on otherwise in-line results. The CEO said that the company will not reach its stated goal of 13% to 15% growth in earnings per share next year; growth that analysts had baked into consensus estimates at 14.5%. This disappoint is due to the Caremark unit, which could see earnings drop as much as 10% to 12%.

We have an Undervalued rating on CVS coming into this report and following the sell-off we are likely to maintain this stance following the weaker results from Caremark. The company announced that it will buy back $2 billion worth of stock through 2011, suggesting that they are trying to support the stock. With the stock selling below its historically normal price-to-cash earnings and price-to-sales ranges, this stock still looks attractive to the long term investor. Although, according to our methodology, we continue to view its closest competitor Walgreen’s (WAG) as the most attractive stock in the pharmacy space.

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Comments

[satyr]

You fail to mention that CVS is also being investigated. The details are not known, but there have been various allegations made with respect to anti-trust, information sharing between the two sides of the business, and other related issues that are perceived to be harmful to the consumer.

I have followed pharmacy rather closely since 2003 and have observed CVS/Tom Ryan and their approach to growth. On the one hand, I give him credit for being very aggressive and able to drive a hard bargain. They stole the Eckerd chain and also Caremark. On the other hand, he is just the kind of figure that you find embroiled in the ugliest of scenarios, whereby hubris causes one to lose sight of integrity and legal doctrine.

By chance, I have had the unwelcome opportunity to watch how CVS/Caremark operates from a customer's perspective over the past year as I have been assisting a family member who has coverage through an employer medical plan. Their inability to communicate internally is mind boggling. You can call them about an issue and if you talk to 5 people you will get 5 distinct answers, all of them in conflict. It is no wonder that they have lost clients.

All of this is not to say that the stock is a bad buy (or a good one). Ryan will pump hard to bring the stock price back. But, he'd better be careful. He made some fairly big promises that he now can't deliver. It would be interesting to know when it became apparent that these contracts would be lost. This company has been a Wall Street darling for a while, which is always a bad sign. Caveat emptor.

2009 Nov 06 03:43 AM

[tep]

The "investigation" is nothing more than a union/democrat ploy to unionize CVS. Do your homework!

2009 Nov 06 08:19 AM

[G. Kahn]

I wondered what the politics here might be. The major contracts lost were NJ medicare (legendarily corrupt liberal gov), Ohio medicare (where the state authorities used their position to investigate Joe the Plumber) and Chrysler ... no mystery there.

I sold CVS a month or two ago simply because there is no way for me to know what the gov was going to do to the industry, or to individual players. Until Thursday it was looking like a bad sell, but the point isn't so much whether it's been up or down as that the fate of businesses lies increasingly in the hands of the grossly empowered political class, rather than in the hands of its management. Who wants to invest in that climate?

2009 Nov 08 01:24 AM