CVS Caremark: Enhancing Its Revenue Streams

Dec. 5.13 | About: CVS Health (CVS)

The Affordable Care Act, which ensures affordable and quality health benefits for American residents, will be fully implemented in 2014. This will act as a growth catalyst for drug retailers in the U.S. CVS Caremark (NYSE:CVS) is in the right position to capitalize on this opportunity, as it is the only drug retailer that has its own Pharmacy Benefit Management, or PBM, segment. Under its PBM segment, the company contracts and negotiates with drug manufacturers to make drugs accessible to a network of more than 65,000 retail pharmacies. Along with this, PBM designs customized prescription management services for its clients, which are in accordance with their drug needs.

CVS Caremark provides prescription management services to over 2,000 health plans, which include corporations, insurance companies, and government entities. This is approximately 70% of the market share, when it comes to management of clients' health plans, which makes the company one of the largest pharmacy health care providers in the U.S.

With full implementation of the Affordable Care Act, 30 million American residents, who were previously deprived of health services, will have access to health care. For this, CVS Caremark will be participating in the public and private healthcare insurance exchange, which will drive the company's revenue in 2014. The private exchange of a health insurance plans permits the employer of an organization to choose a plan from multiple insurance issuers, and the public health insurance exchange is the state offering insurance to its residents. Since the private exchanges provide the same coverage as mandated under the Affordable Care Act, the insuree gets the same kind of insurance benefits. With this, private exchange are expected to witness an upsurge and will contribute towards the CVS revenue growth next year.

In addition to this, 75% of its health insurance clients renewed their plans for 2014, and the company has won new contracts worth $1.8 billion, which will further add to the company's revenue in 2014. The reason behind the renewal and new contract is that CVS health insurance services are designed to lower clients' costs and are customized to their needs, leading towards more clients for CVS's health plans services.

Management has raised its profits outlook for the year, on an account of better third quarter results. In the third quarter of 2013, the company's revenue from the PBM segment rose 7.8%, bringing it to $19.5 billion. This contributed approximately 61% of the total revenue, which is up from 55% in 2011. The company is now expecting its earnings to be in the range of $3.98 to $4.01 per share, up from the previous forecast of $3.90 to $3.96 per share.

Another leading player of pharmacy business management in the U.S. is Express Scripts Holding (NASDAQ:ESRX). This company is also expected to benefit from the full implementation of the Affordable Care Act in 2014. The company manages more than one billion prescriptions every year. Express scripts anticipates that private exchange will represent more than 2% of the prescription by the year 2016, which is less than 0.25% currently. To capitalize on this, Express Script is also well positioned to participate in private exchange. Express Scripts already manages a huge client base and the expanded number of health insurance with implementation of Affordable Care Act is expected to be a growth catalyst for the company.

Adopting strategies to build strong position against its rival.

Walgreen (WAG) holds the first position with 8,105 drug stores in the U.S. as compared to CVS Caremark currently operating 7601 stores. To enhance the presence and build stronger position against the market leader, CVS is adopting a strategy of expanding its store counts along with the expansion of its offerings.

CVS has a target to increase 2% to 3% square footage in the U.S. by the end of this year. For this, the company opened 71 new or relocated stores, resulting in 48 net new stores in its third quarter of 2013. Along with the store counts expansion, the company is expanding its specialty pharmacy services offerings, which provides personalized services to its clients with critical diseases. The company currently operates approximately 30 specialty stores, which are performing significantly well. This fact was evident in the third quarter result updates, wherein these stores witnessed revenue growth of 22% on year over year basis.

To further enhance this segment, recently CVS Caremark has agreed to acquire Coram LLC, a specialty pharmacy service of privately owned Apria Healthcare Group for $2.1 billion. The acquisition will enable CVS to provide therapies such as antibiotics, nutrition and pain medicine, thus enhancing its earnings. The deal is expected to close by the first quarter of 2014 and the transaction is expected to boost the company's earnings by $0.03 to $0.05 per share in 2015. Various moves by CVS make me believe that the company will hold a strong position over the coming years and will give a tough competition to Walgreen.

Walgreen is also adopting a similar strategy of expanding its store count to enhance its revenue stream. The company is expanding its store count in North Carolina, which covers 15 metropolitan areas with a huge population. On November 8, 2013, Walgreen acquired privately owned regional pharmacy chain Kerr Drug, which includes 76 new retail stores and a specialty pharmacy business. In fiscal year 2012, Kerr Drug stores posted revenue of $381 million from its stores. By taking a conservative approach, I assume these stores will generate the same amount of revenue in the coming years, thus enhancing Walgreen's top line. As far as revenue growth rate is concerned, Walgreen's revenue has increased at a CAGR of 9.40% over the past 10 years, bringing it to a trailing twelve month revenue of $72.21 billion.

Stock Valuation

Quarter

Book value Per Share($)

Quarter end Market Price

MP/BVPS

Fourth quarter 2012

30.63

48.34

1.57

First quarter 2013

31.11

54.99

1.76

Second quarter 2013

31.71

57.18

1.8

Third quarter 2013

32

56.75

1.77

Click to enlarge

Currently, CVS Caremark's book value is 32 times its outstanding shares, and over the past four quarters, the company's book value per share, or BVPS, has grown approximately 4.5%. The company's strategy of expanding its drug stores, as discussed above, supports this growth rate. On the other hand, its market price per share has grown 17.39%, which has supported its market price to book value multiple. Its market price to BVPS has consistently been above one, as shown in the table above, implying that thet stock is consistently trading above its book value in the trailing twelve month period.

In the last 12 months, while the book value has remained almost constant, the market price has grown almost 18%. This indicates that the company's stock price has improved without any significant investment in its assets. This is a good indicator of future growth potential for the company's stock price, thus providing returns to its investors in terms of capital appreciation.

Buy this drug retailer for healthy future

CVS Caremark is in the right position to benefit from the implementation of the Affordable Care Act in 2014. This will enhance the company's pharmacy benefit management business, as more American residents will be able to avail medical health care. This will enhance the company's revenue over the next year. Along with this revenue stream, the company has adopted a strategy of expanding its store counts, leading towards increased revenue streams. As far as its stock valuation is concerned, CVS Caremark is an undervalued stock, as discussed above. Strong fundamentals and attractive valuation make me believe this stock is a buy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.