CVS Caremark Corporation (NYSE:CVS)
UBS Global Healthcare Conference Call
May 20, 2014 8:00 AM ET
Larry J. Merlo – President and Chief Executive Officer
Steven J. Valiquette – UBS Securities LLC
Steven J. Valiquette – UBS Securities LLC
All right. Good morning, welcome to day two of the UBS Global Healthcare Conference. I’m Steven Valiquette, Healthcare Distribution Analyst here at UBS. So, for the early call today, we have CVS Caremark. this is not a fireside chat, this is formal presentation. Now with us to tell us more about the company is Larry Merlo, the company’s CEO.
So with that, I’ll turn it over to Larry.
Larry J. Merlo
Well thanks, Steve. Good morning, everyone. we appreciate you joining us today to learn more about CVS Caremark. Before I get started, I’d like to call your attention to the slide about our forward-looking statements, I’d ask you to take a moment to review it. Since I know you’re all speed-readers here, so what I plan to cover this morning, I’ll start by discussing our unique combination of industry-leading assets and how those assets best position CVS Caremark to capitalize on the changes that are occurring in the healthcare environment. and then I’ll finish up by talking about our focus on enhancing shareholder value.
Now looking ahead, we see our unique combination. we refer to it as ability and agility that position CVS Caremark to thrive in this changing healthcare landscape. and our ability is defined by the fact that we brought together an unmatched breadth of assets and expertise to drive innovation and that innovation is delivering results for our clients, our customers and our shareholders.
Our agility is routed in the fact that while we’ve laid out a clear direction and long-term strategy is everyone here is aware, the marketplace is undergoing significant change. and we see ourselves, having the nimbleness to respond to those changes, while continuing to deliver strong results. So we take a minute and briefly review our business.
Our retail pharmacy business is strong. it has consistently outperformed the industry. Over the past five years, we’ve gained significant share, versus other chains in the overall retail market. and today, we feel more than one in every five prescriptions here in the U.S. And there have been several drivers of this performance including the growth in our store base and continued improvements in serving our customers. Significant share gains from the Walgreen to the Express in past, that occurred back in 2012 and our retention of a very high percentage of those customers.
And then finally, the growth of labs under management at Caremark, and growing our share of that business. and you can see on this chart that our growth in the Caremark book of business has helped to fuel our retail performance. but at the same time, you can also see that we have outperformed the market, even when adjusting for the Caremark’s synergy.
Another key driver of our growth has been the significant investments that we’ve made in our retail pharmacy adherence programs. these programs actually help our patients get on and stay on the right medications, and thereby providing significant benefits for patients, payers and our business.
Now leveraging Caremark insights and clinical expertise, we built and we launched our first retail adherence programs back in 2008 and since the initial rollout we’ve enhanced and expanded these offerings. and in 2013, we actually executed 75 million live clinical interventions at our retail pharmacy counters.
As a result of these programs, we’ve been able to drive substantial improvements to our adherence rates at a pace well above the competition, in fact our medication possession ratio, which is a standard measure of adherence now stands almost 94 percentage points ahead of the competition. And we’re certainly not done as we’re looking to build on this platform to unlock additional patient care breakthroughs by further integrating across our channels to create seamless, favored and even more effective interventions. And given our wide reach, these interventions are having a meaningful impact on reducing the estimated $300 billion in avoidable medical costs incurred each year as a result of medication on adherence.
Another key to our growth has been the success of our extra care royalty program. We have about 70 million active cardholders today, 69% of our front store transactions involved extra care. we’ve spent 16 evolving and perfecting program, which means the depth of our customer insights are unpatched, and we’re continuing to invest in extra care to stay on the leading edge.
Our personalization is core to our retail strategy and extra care is really the engine behind all of our personalization efforts and we have a number of initiatives underway, all of them are designed to help us connect directly with individual consumers to deliver a more personalized experience.
Another key piece of our retail and enterprise growth is MinuteClinic. MinuteClinic is the largest and fastest growing retail clinic operator here in the country. We now have more than 800 medical clinics in our stores and 28 states in the District of Columbia. We provide a care to more than 20 million patients since the inception of MinuteClinic. And our 2,200 nurse practitioners provide high-quality, affordable, walk-in healthcare services, seven days a week, no appointments needed. And I think you’ll find an interest thing that about half of our patents are actually seen during the evening hours, as well as on weekends.
So I think many of you are aware of that there is a growing shortage of primary care physicians here in the U.S. The demand is expected to outweigh the supply by about 45,000 doctors by the end of this decade. At the same time, with millions of Americans expected to be newly insured under Health Reform, the gap between supply and demand is widening. and while that’s occurring, we’re expanding our MinuteClinic footprint and broadening our services to help fill this void.
In addition, we now have clinical affiliations with more than 30 major health systems around the country. And what we’re doing here is we’re actually integrating electronic records to allow for the transmission of clinical information between our systems, ultimately leading to better care at lower costs. So looking ahead, we plan to have a footprint of about 1,500 clinics in at least 35 states by 27 teams.
Now moving on to our PBM business, we’ve delivered strong, top and bottom line growth in recent years, and we’ll continue to build on this momentum as we continue to gain share in the marketplace. In the 2014 selling season, we delivered gross new business wins of about $5.5 billion, net new business of $3 billion.
Our clients are telling us that we’re being selected, not only because we’re competitive on price, but also because of the unique capabilities we’re able to deliver, capabilities that enable them to better manage their costs, enhance access and improve their member’s health.
So overall, we’re very pleased with the selling season, and the positive feedback that we’re getting from our clients and consultants on our business model. It’s also important to note that these selling season figures do not reflect $1.3 billion of vast Medicare Part D revenue, in 2014, which resulted from the sanction that we had been under through most of the 2013 calendar year, and while the sanction prevented us from participating in open enrollment last fall, Med D does remain a very important part of our growth strategy. I think about the 15 million people aging into Medicare by 2020. the drug spend in the Medicare space is expected to grow at an 8.6% compounded annual growth rate, with individual PDPs actually feeling that growth.
Today, we remain the number three competitor in this important market, and we see ourselves having the scale to compete effectively going forward. We currently cover about 6.8 million lives through our SilverScript PDP products, as well as through our health plan clients who sponsor their own PDP and MA-PD programs.
And I should also note that the sanction has been removed. And we are once again, enrolling Medicare beneficiaries as they age into the program, and again, we see significant opportunity to grow the business over the long-term. Another key growth driver in the PBM area is Medicaid. we participate in this growing market through our health plans, when Medicaid is in a managed program versus a fee-for-service program.
Today about 30 million people are enrolled in Managed Medicaid. This number is expected to increase to approximately 43 million by 2016. And that’s a 42% growth over a three-year period. This growth will come from two sources. First, from the continuing transition of fee-for-service into Managed Medicaid, and then second from new enrollees resulting from the Affordable Care Act’s expanded eligibility.
The most recent available data indicates that 3 million individuals have gained coverage through this expansion thus far. and it’s forecasted that this number will continue to increase in the coming months. Now, as we expected, we’ve seen a slight positive impact on our results from this growth in the Medicaid segment. And we continue to believe that CVS Caremark is well positioned to serve these new customers across our enterprise assets.
Today, we have about a 28% share of the PBM Managed Medicaid market and we’re poised to maintain our leadership position in this growing market given our expertise. At the same time, we also see interest from Managed Medicaid providers in narrowing their retail pharmacy networks. Again, this gives us an opportunity to gain enterprise share through our CVS pharmacy stores.
Another very important growth driver in key area of focus for our PBM client’s specialty pharmacy, I think as everyone here is aware specialty encompasses high cost drugs for complex conditions whether talking about rheumatoid arthritis, MS hepatitis. With specialty expenditures growing 15% to 20% annually, payers are certainly increasingly focused on controlling the specialty costs. At the same time, with 50% of specialty spend expected to flow through the medical benefit over the next few years, payers are increasingly looking to their PBM to help manage this portion of spend as well.
I think what’s unique about the CVS Caremark model is we have both the tools and technology to manage specialty across both the pharmacy and medical benefit. We have an industry leading 21% share of the specialty market with more than $20 billion in specialty revenues either filled or managed across the enterprise. We’ve also taken a leadership role in terms of expanding the use of formulary management into the specialty area. And also our new specialty connect products that actually fills an unmet consumer need from more convenience and access to specialty meds.
And finally, our recent acquisition of Coram actually gives us a leading position in the infusion market that further expands are competitive specialty offering. Now, I think as you’ve seen, we have strong competitive offerings, leading market positions in each of our core businesses. However, the industry is undergoing its most transformative shift in decades and as we sit down and evaluate all the moving parts in the healthcare marketplace, we actually see four key trends that are most important and impactful to how we are positioning our company for the future.
First, we see the Affordable Care Act expanding coverage to more than 30 million Americans and the payer mix changing substantially with more lives shifting to health plans. Second, we see a continued shift towards what we are calling this retailization of healthcare with more consumer choice and accountability growing. Third, we see a greater focus on both cost and quality as the Affordable Care Act is fully rolled out. And payers and providers begin to look for new ways to improve the healthcare value equation.
And finally, the economics of pharmacy will continue to evolve with the greatest growth opportunities coming in the form of share gains and volume growth. As I mentioned a minute ago, CVS Caremark is extremely well positioned to thrive in this changing healthcare landscape because of our integrated model.
Now, as I am sure you’ve seen the latest available data suggests that more than 8 million individuals have enrolled in the public exchanges. That said, it’s still too early to estimate the impact this might have on utilization trends in the near-term given that the mix of those lives is still unclear.
However, we continue to expect our coverage expansion will provide a long-term securer tailwind with were the 30 million Americans gaining insurance coverage by 2018.
And although there are a number of moving parts related to changes in payer mix and the growth in exchanges, collectively we do expect these changes will be a net positive for our business this year and beyond. We’re participating in coverage expansion in both of the public and private exchanges.
And so PBM, we’re participating in the public exchanges through our health plan clients on a carve-in basis where the health plan offers integrated medical and pharmacy benefits and we provide the PBM services. In fact our health plan client footprint actually expands 25 states and it covers nearly 70% of the eligible exchange population.
In the private exchanges, we’re participating through both a carve-in basis again through our health plan clients as well as on our carve-out basis, as a standalone PBM where we have direct prescription benefit offerings on the exchange products.
We’re also playing an important role in providing coverage to retirees through our SilverScript prescription drug plan as well as through our health plan clients PDP and LAPD businesses. It’s also important to remember that our opportunities to participate in the exchanges are not limited to just PBM, but they span across the entire enterprise to include our retail pharmacies and our MinuteClinics.
In particular, we expect that our retail business will benefit from the expansion of coverage along with our ability to drive incremental prescriptions through that retail fixed cost structure. So while there are a lot of moving parts all things considered, we see ourselves very well-positioned.
Now one of the truly unique aspects of our model is the ability to support health plans through our assets again across the CVS Caremark enterprise whether or not we’re the PBM and our consumer expertise in this new business, the consumer world of healthcare is being welcomed by health plans across the country and leveraging our retail footprint, we can support health plan marketing initiatives ranging from limited pilot marketing programs to full scale educational programs.
Now some of these health plan partnerships also include participation in preferred or restricted retail pharmacy networks and many are taking advantage of the convenient and affordable MinuteClinic services as well as cost saving PBM services and programs to better manage specialty pharmacy expenditures.
And while our strategy enrich will continue to grow and evolve, the names listed here are just a few examples of some large national and regional health plans that are leveraging our enterprise capabilities even though they are not PBM clients.
Now with the implementation of the Affordable Care Act and the continued growth in Medicare, we’re seeing a rapid increase in the number of consumers choosing their own health plans and this trend combined with continued cost pressures is driving rapid growth of consumer directed or high detectable health plans and as a result of push for our greater value in transparency in the healthcare marketplace.
And our advantage with CVS Caremark lies in our consumer friendly channel agnostic solutions that deliver value for clients and their members. We have decades of experience in the business to consumer environment as a result, we have a trusted brand, we have name recognition with both our consumers and plant sponsors and that really underscores our ability to capture share and win new business in this era of consumer driven healthcare.
Our innovative channel agnostic offerings such as maintenance choice or pharmacy advisor, we see that transforming the value equation for PBM clients and their members, delivering a unique combination of savings, quality and connivence and our ever growing footprint of convenient retail and MinuteClinic locations actually again extends our reach with consumers.
We’ve also invested significantly a new digital capabilities to enable a strong multi-channel reach and integrated digital offering, and then our low cost transparent pricing model at MinuteClinic will be especially attractive to cost conscious consumers seeking our greater value through the most cost effective channel of care.
Now with so much change occurring in the broader healthcare market, we are also seeing the economics of our business evolved and while some of our traditional sources of growth are beginning to slow, we expect strong growth in script demand to create new opportunities for growth and share gains.
Going forward, we believe the greatest opportunities for EBIT growth will come from winning new lives and gaining a greater share of prescription dispensing and consumer wallet and in terms of winning lives, we’ve been very successful in growing our PBM book of business over time and you can see on this slide total adjusted claims are up 42% since 2008.
Now in addition to growing our overall PBM book of business, we’ve also been successful in gaining a greater share of PBM client spend across our enterprise channels. And since 2008 PBM claims filled in CVS Caremark channels meaning either CVS retail or Caremark mail are up 55%. And that compares to the 42% growth in all claims that was on the prior slide.
So I think you can see that we’re gaining share of a growing pie which we see as a formula for success and by combining our mail and retail capabilities, we can drive greater value, greater savings for our clients and their members while also maintaining an attractive economic profile on the business from CVS Caremark’s perspective.
And despite the progress that we’ve made that you can see on these past two slides, we do see significant opportunity to continue to grow our enterprise share of PBM client spend.
Now before I wrap up, I’d like to touch on our continued commitment to enhance shareholder value and over the past few years this has been our roadmap for driving value. It will remain our call it GPS going forward and it actually includes three main pillars. First is our focus on driving productive long-term growth, second is our expectation to generate significant levels of free cash flow and finally our disciplined approach to capital allocation.
In 2014, we expect to maintain our strong track record of successfully managing all three of those pillars now earlier this month we announced our first quarter results, the year is off to a strong start. Adjusted earnings per share grew 22.5% to $1.02 per share and both our PBM and retail segments delivered solid operating profit growth and the underlying trends in our business where very strong. We also generated $1.8 billion in free cash flow putting us well on our way to achieving our full-year goals.
On our first quarter call, we also reviewed our full-year 2014 guidance and for the year we’re expecting adjusted earnings per share to be in the range of $4.36 to $4.50 per share reflecting solid year-over-year growth of above 10% to 14%. We expect to once again generate a substantial amount of cash flow with free cash flow expected to be between $5.5 billion and $5.8 billion and we’ll continue to deploy that cash to return significant value to our shareholders.
At our analyst day last December, we laid out our priorities for capital deployment over the next five years, and our steady state earnings targets through 2018 should lead to a substantial amount of cash close to $40 billion, that will be available to enhance shareholder returns. So, if you ask Larry, well exactly, what are the priorities for that cash? Well, first we’ll make strategic investments that drive the long-term growth and financial returns for our business.
Second, we’ve set a targeted dividend payout ratio of 35% by 2018, versus the current level of approximately 24%. and this would imply a compounded annual dividend growth rate of nearly 18%. And then finally, absent high returns strategic investments, perhaps $45 billion of annual value enhancing share repurchases could be executed under normal conditions.
Now, we are providing 2014 guidance to the Analyst Day. We announced that our Board of directors had approved and annual dividend in 2014 of $1.10 per share that’s up $0.20 per share or 22%. Additionally, our board approved the new $6 billion share repurchase program, which reflects our ongoing commitment to returning value to our shareholders. And at the same time, it gives us the ability to continue our successful buyback program. And with that, we expect to complete another $4 billion of share repurchases throughout 2014 continuing our recent takes.
So in summary, we are very optimistic about the opportunities that lie ahead for our company. We believe changes and the healthcare environment are creating significant opportunities for growth and we’re focused on innovative solutions to better meet the changing needs of our clients and our customers. Our unique model creates sustainable competitive advantages for us, and real value for our patients, customers, clients and this is how we’ll continue to win share in the marketplace.
We’ll continue to migrate towards a greater focus on enterprise growth, defined by winning lives and capturing a greater share of pharmacy spend. even if we’re not the PBM, and we’re also committed to enhancing shareholder value through strong earnings growth, substantial cash generation and disciplined capital allocation practices.
So with that, again, I would like to thank you for your time this morning and we’ll be heading to the Carnegie West Room, which I think is across the hall for the break-out session. Thank you.
[No Q&A session for this event]
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