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The healthcare system in the U.S. is evolving. CVS Caremark (NYSE:CVS) is among the leading drug store chains in the U.S. CVS has been making efforts to diversify its business to become an important part of the healthcare system and is doing well to keep up with the constantly evolving industry. Recently, the company did well by merging its retail and PBM business, which offers diversification and value to shareholders. Also, the company has been taking initiatives, e.g. eliminating tobacco sales, to increase collaboration with doctors and healthcare systems, which will portend well for the company in the medium-to-long term. Moreover, the company continues to post a healthy financial performance.

The company reported a solid financial performance for 4Q2013. Adjusted EPS for the company for the recent fourth quarter came out to be $1.12, beating the consensus estimates of $1.11, representing an increase of 16% year-on-year. Better-than-expected earnings for the recent quarter marked the eight consecutive quarter of an earnings beat, reflecting a solid momentum for the business. The company also reported better-than-expected revenues for 4Q2013; reported revenues for the quarter came out to be $32.8 billion, up 4.6% year-on-year, beating the consensus estimates of $32.68 billion. CVS's full year, 2013, revenues increased by 3% year-on-year to $127 billion. Also, the company has done well to strengthen its margins. The table below shows margins improvement for CVS in the recent past.

 

3Q2013

4Q2013

Gross Margin

18.7%

19.3%

Operating Margin

6.5%

6.8%

EBITDA Margin

8%

8.15%

Source: Company Reports and Calculations

Despite the fact that the company announced to end tobacco sales and intense competition in the industry, CVS slightly increased its solid guidance for 2014. The company expects net revenues to grow in a range of 4.25%-5.5% in 2014, as compared to the previous guidance range of 4%-5.25%. Also, the company expects to maintain its gross margin and improve operating margin by 0.15%-0.25% in 2014. The following table shows CVS's guidance for 2014.

 

Net Revenue Growth

Adjusted EPS Growth

Operating Margin Improvement

Guidance - 2014

4.25%-5.5%

10.25%-13.75%

0.15%-0.25%

Source: Company Report

Stock Price Drivers

The company has been focusing on driving front end sales growth, which it has named 'smart growth'. The company is committed to strengthening and focusing more on the health and beauty category, where the company believes it has underpenetrated. Also, as consumer demand for private label (brands/products) increases, the company aims to increase its private label sales. Currently, private label make up approximately 17.5% of total front end sales, which CVS expects to increase to 20% in the future. Moreover, CVS targets for more improvement in its 'ExtraCare' initiative, by providing more personalization to its customers, which is likely to increase store traffic.

Also, the company's initiative to exit from tobacco sales will portend well for the company's performance in the future. The announcement to exit from tobacco sales will help the company align itself with patients, healthcare providers and clients, consistent with CVS's long term plan, as it is eyeing to play a larger role in the U.S. healthcare system.

CVS has the highest share in the PDP and managed Medicaid market. The company's earnings in the future are likely to benefit from increased coverage expansion, as it is expecting insurance coverage to increase by 14% from 2013 through 2018. Also, an expected annual increase of 18% from 2014-2018 in specialty drug spending and an expected pick up in the sales of generic launches in 2015 is likely to portend well for the stock price. The company expects generic sales to increase to $14.7 billion in 2015, up from $9.3 billion in 2014.

As the company is positioning itself well to take advantage of the changing healthcare system in the U.S., it has also been maintaining rich shareholder return policies. The company currently offers a sustainable dividend yield of 1.5%. CVS announced a hefty 22% dividend increase in 2013. Also, as the cash flow generation for the company remains strong, it could further announce a notable dividend increase. Along with dividend offering, the company is anticipating to repurchase $4 billion worth of common stocks in 2014 (4.7% of its current market capitalization), under its ongoing share repurchase program of $6 billion. Share repurchases are likely to provide earnings growth and boost CVS's ROE. Cash flow generation for the company stays solid, and it expects operating cash flow and free cash flows to be in a range of $6.9-$7.3 billion and $5.5-$5.8 billion, respectively, in 2014.

Conclusion
CVS is one of the best positioned companies in the industry to benefit from the changing healthcare system in the U.S. The company has been making slight changes to its already strong business model to keep up with the industry changes. The company's initiatives like 'smart growth', increasing collaboration with the healthcare systems, potential benefits from expansion in insurance coverage and rich shareholder return policies make me bullish on the stock. Also, analysts have projected a robust next five year growth rate of 13.5%.

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 Caremark To Thrive In Evolving Healthcare Industry In U.S.