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A few days back I wrote an article on the irrational price fluctuation of CVS Caremark Corporation (NYSE:CVS) following the news of their exit from the tobacco business. Today I will compare the earnings release of the fourth quarter earnings release with analysts' expectations to see what the future holds for the company.

Actual CVS Earnings

Net revenues for the quarter were $32.8 billion beating analysts' estimates by $0.1 billion. Compared to the fourth quarter of 2012, the net revenues of the company grew by 4.60% YoY.

With regards to the bottom line, the full year net income was $1.27 billion, indicating an increase of more than 12% compared to the net earnings generated in the fourth quarter of 2012. Per share earnings of the company stood at $1.05. However, excluding non-recurring events, net earnings per share increased by $0.07, leading to an adjusted EPS of $1.12. Analysts had projected per share earnings of $1.11 for the quarter.

The growth in the bottom line of the company was realized as a function of growing profitability from the Pharmacy Benefit Management (PBM) segment and Retail Drugstore segment sales. The PBM segment showed revenue growth of 5.2% YoY while the Retail Pharmacy segment's revenues grew by 5.2% YoY.

The increased revenue and profitability from the PBM segment is a cumulative function of rising inflation, new drugs added to the product portfolio, and a swelling client base. With regards to the Retail Pharmacy segment its revenues were boosted by growing prescription volumes, larger basket per customer sales, and the upward trend in the same store sales. Same store sales for the segment increased by 400 basis points year-on-year.

Financial Stance of CVS Caremark

The debt to equity ratio of the company stands at 26.48 compared to the industry average of 18.04. It is apparent from CVS's PEG ratio of 1.11 that the company is presently in a growth phase. It is quite normal for growing companies to raise high levels of debt. Having a relatively higher level of debt on one's balance sheet is not an indicator of poor financial standing in itself.

To better understand the financial strength of the company, I calculated the CFO/Debt ratio on a quarterly basis. Looking at the CFO/debt ratio of the company, it is apparent that the company's ability to pay off its debt through continuing operations is escalating. Mathematically, the CFO/Debt ratio of the company has risen at a CAGR of approximately 43% over the recent four quarters. Examining the drivers of ratio, I calculated that total liabilities of the company indicated a cumulative growth of 6.40% over the past four quarters while the cash flows from operations showed a stellar cumulative growth of 52%. The growing trend in the ratio is evident from the graph below.

Source: Quarterly Earnings

Shareholder profits

CVS Caremark generously rewards its investors through a two-pronged approach:

  1. Continuous dividend raises
  2. Share repurchases

A recent earnings release report indicates that the company raised its per share dividends by 38% in 2013 and plans to raise them even further in 2014. The following chart shows a gradual but continuous rising trend in the dividend yield generated by the company over the past five years.

Source: Y-charts

With regards to share repurchases the company has bought back 108 million shares over the past two years reflecting an average of 13.5 million shares per quarter. Share buybacks are normally practiced by companies when they consider their stock undervalued in the market. So, the share buybacks usually lead to a rise in price benefiting remaining investors in return.

Future Outlook

The company recently announced that it would not be selling tobacco-based products from October onwards leading to an estimated annual loss of $2 billion into the future. However, the loss is meager when you compare it to the benefits that can be extracted from the move. I strongly believe that CVS will receive contracts and partnerships from major drug producers, hospitals, and insurers alike due to this move. Obama Care will hugely benefit the company in this regard as well.

To cover its front on the surging generic drug sales in response to patent expiries, the company partnered with Cardinal Health Inc. (NYSE:CAH). The joint venture will enable the company to reap profits from generic drug sales. This will cushion the revenue base of the company even further.

CVS anticipates flattish growth this time around, as evident by its 2014 earnings guidance released with the earnings report of the fourth quarter of 2013. The company projects a consolidated revenue growth within the range of 2.75% to 4.25%. Per share profit of the company is estimated to be $1.09-$1.12. However, revenues of the company will escalate as it starts reaping the benefits from the CVS-Cardinal joint venture and "no more tobacco" strategy.

Conclusion

The long-term prospects of the company appear bright. The company has shown strong performance over the recent historical period. Furthermore, investor returns are expected to increase over the future quarters considering the fact that the company has maintained a history of reasonable dividend increase and the fact that its earnings will now be distributed across fewer investors. Lastly, the company is proactively repositioning itself in the wake of changing industry scenario of: 1) changing consumer behavior against tobacco use; 2) surging generic sales. Based on these facts, I would like to maintain my opinion that the company is a long-term 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.

Source: CVS - Earnings Outlook Supporting Growth Prospects