CVS Caremark Corporation (NYSE:CVS)
Wells Fargo Healthcare Conference Call
June 18, 2014 11:15 ET
Dave Denton - Chief Financial Officer
Nancy Christal - Senior Vice President, Investor Relations
Peter Costa - Wells Fargo
Peter Costa - Wells Fargo
Hello, everyone. I am Peter Costa. I am Wells Fargo’s managed care and pharmacy services analyst. We are very pleased to have today with us CVS Caremark. And with us from CVS Caremark is Dave Denton, the CFO and Nancy Christal, the VP of IR. Hopefully, Dave has got some great things to tell us here and share with us. He is going to do a presentation. So, this is the normal fireside chat, where we are going to do a presentation here. And as you know, CVS is one of my top picks and certainly my top picks in the pharmacy services, PBM space. Go ahead, Dave.
Dave Denton - Chief Financial Officer
Great. Thank you everybody. Thank you for being here with us this morning and thank you for spending a little time learning a little bit more about CVS Caremark. And before I begin, just want to spend just a minute, this is our forward-looking statement just call your attention to that. So, I think you should be familiar with it.
So, here is what I plan to cover this morning. First, I will start by discussing our unique combination of industry leading assets and how those assets best positions CVS Caremark to capitalize on the changing healthcare environment. And then I will finish up by talking about our continued focus on enhancing shareholder value. Looking ahead is our unique combination of both agility and ability that positions CVS Caremark to both thrive in the changing healthcare landscape. Our ability is defined by the fact that we have brought together an unmatched breadth of assets and expertise to drive innovation. And that innovation is delivering results for our clients, our customers as well as our shareholders. Our agility is within the fact that while we have laid out a clear direction and a long-term strategy, the marketplace is undergoing significant change. And we have the nimbleness to respond to those changes while continuing to deliver solid financial results.
So, let’s take a minute and just review our businesses. Our retail pharmacy is strong. It has been consistently outperforming the industry. Over the past five years, we have gained significant share versus other chains and versus the overall retail marketplace. And today, we fill more than one in five of every prescription in the United States. There have been several factors that have driven this performance. First, growth in our slow base and continued improvements and customer service has continued to fuel our growth, significant share gains from the Walgreens-ESI dispute back in 2012, and more importantly, our retention of a high percentage of those customers, and finally, the growth of lives under management at Caremark and our growing share of that business.
You can see on this chart that our growth in the Caremark book of business has helped fuel our retail performance. However, you can also see that we have outperformed the market even when adjusting for that synergy. Another key driver of our growth has been the significant investments we have made in our retail adherence programs. These programs help our patients get on and stay on the right medications and thereby generate savings for our patients, our payers as well as our business. Leveraging CVS Caremark’s insights and clinical expertise, we have built and launched our first retail adherence programs back in 2008. As this is the initial rollout, we have enhanced or expanded these offerings and in 2013, we executed 75 million live clinical interventions at our CVS/pharmacy retail outlets. And as a result of these programs, we have been able to drive a substantial improvement and adherence. And it appears well above the competition.
In fact, if you look at the medication possession ratio, which is essentially a standard measure for adherence, we now stand almost 9 full percentage points above the competition. And we are not done as we continue to building on this platform to unlock additional patient care breakthroughs by further integrating across our channels to create seamless, tailored and even more effective clinical interventions. Given our wide reach, these interventions have a meaningful impact on reducing the estimated $300 billion in avoidable medical cost each year in the U.S. as a result of medication non-adherence.
So, another key of our growth has been the success of our ExtraCare loyalty program. We have about 70 million active cardholders a day and more than 80% of our front store sales involve the ExtraCare card. We have spent 16 years evolving and perfecting this program which means the depth of our customer insights is unmatched in the marketplace. And we are investing in ExtraCare to stay on the leading edge. Personalization is key and core to our retail strategy and ExtraCare is the engine behind all of our personalization efforts. And we have a number of initiatives underway all of them 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. It is the largest and fastest growing clinic operator in the country. We now have more than 800 medical clinics in our stores in 28 states plus D.C. We provide care to more than 20 million patients since the exception of MinuteClinic and our 2,200 nurse practitioners provide high-quality affordable walk-in healthcare services seven days a week without an appointment. And about half of our patients are seen on evenings and on weekends. And there is a growing shortage of primary care physicians in the U.S. and the demand is expected to outweigh the supply by some 45,000 physicians by the end of this decade and with millions of Americans expected to be newly insured under health reform, the gap between supply and demand is growing. And while this is occurring, we are expanding our MinuteClinic footprint and broadening our services to help fill in this void. In addition, we now have clinical affiliations with more than 30 major health systems around the country, where we are integrating our electronic medical records to allow for the transmission of clinical information seamlessly between our systems, ultimately leading to better care and lowering cost. And looking ahead, we plan to have a footprint of about 1,500 clinics in at least 35 states by 2017.
Moving to our PBM business, we have delivered strong top and bottom line growth in the recent years and we are building on this momentum as we continued to gain share in the marketplace. In 2014, the selling season we delivered gross new business wins of about $5.5 billion with net new business of about $3 billion. Clients are telling us that we are being selected not only because of our competitive price offering, but also because of our unique capabilities we deliver and our high level of service. Our capabilities enable them to better manage their costs, enhance access and improve their members’ health. Overall, we are very pleased with the selling season, the positive feedback we are getting from both clients and the consulting community. It’s important to note that these selling figures exclude $1.3 billion of lost revenue associated with Medicare Part D for 2014, which was the result of the sanction we were in for most of 2013.
And while the sanction has prevented us from participating in the open enrollment last fall, Medicare Part D remains a very important part of our growth strategy. With 15 million people aging into Medicare by 2020 drug spend in the Medicare space is expected to grow at about 8.5% compounded annually with individual PDPs fueling that growth. We remain the number three player in this important market and we have the scale to compete effectively going forward. We currently cover approximately 6.8 million lives through our SliverScript PDP product and through our health plan clients who sponsor their own PDP or their own MAPD program. I should also note that the sanction has been removed and we are once again enrolling Medicare beneficiaries and we see significant opportunity to grow this business over the long-term.
Another key driver of our PBM business is Medicaid. We participate in this growing market through our health plans when Medicaid is in the managed program versus the fee-for-service program. Today, 30 million people are enrolled in managed Medicaid and the numbers are expected to increase to approximately 43 million by 2016 representing a 42% growth over three years. This growth will come really from two sources: first from the continued transition from fee-for-service into managed Medicaid and second from new enrollees resulting from the Affordable Care Act and the expanded eligibility criteria. And the most recent data suggest that about 3 million individuals have gained coverage due to the expansion thus far and is forecasted that this number will continue to increase in the coming months. And as expected, we have seen a slight pause and 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 entire enterprise. And today, we have a 28% share in the PBM managed Medicaid market and we are poised to maintain our leadership position in this growing market given our expertise. We see interest from managed Medicaid providers and narrowing their retail pharmacy networks given the opportunity to gain enterprise share for our retail stores.
Another very important growth driver in key area of focus for our PBM clients is specialty pharmacy. And specialty encompasses high cost drugs for complex conditions such as rheumatoid arthritis, MS and hepatitis. With specialty expenditures growing at 15% to 20% annually, payers are increasingly focused on controlling specialty costs. And with 50% of specialty spend expected to flow through the medical benefit by 2018, payers are increasingly looking to their PBM to help manage this portion of the spend as well.
We have the tools and the technologies to manage specialty across both the pharmacy and the medical benefit. We have industry leading 21% share of the specialty market and more than $20 billion in specialty revenues filled or managed across our enterprise. We have also taken a leadership role in terms of expanding the use of formulary management into the specialty arena. Also our new Specialty Connect product fills an unmet consumer need for more convenient access to specialty meds. And finally, our recent acquisition of Coram gives us a leading position in the infusion market and further expands our competitive specialty offering.
As you have seen, we have had strong competitive offerings in leading market positions in each of our core businesses. However, the industry is undergoing significant change and more transformative shift this decade than probably the last five decades. When we evaluate all of the moving parts in the healthcare marketplace, we see four key trends that are most important and impactful on how we position the company for future growth.
First, we see the Affordable Care Act expanding coverage to more than 30 million Americans and payer mix changing substantially as more lives shift from the employer book into the health plan book. Second, we see continued shift towards what we call the retailization of healthcare with consumer choice and accountability growing. Third, we see greater focus on cost and quality as the Affordable Care Act is fully rolled out and payers and providers look for new ways to improve the healthcare value equation. And finally, the economics of pharmacy will continue to evolve. And quite frankly, the greatest growth opportunity is coming in the form of share gains and volume growth.
CVS Caremark is extremely well-positioned to thrive in this changing healthcare landscape because of our integrated model. And I am sure you have seen this that the latest available data suggest that more than 8 million individuals have enrolled in the public exchanges. That said it’s still too early to estimate the impact that this might have on utilization trends in the near-term given that the mix of these lives is somewhat still unclear. However, we continue to expect coverage expansion will provide a long-term secular tailwind with more than 30 million Americans gaining insurance coverage by 2018. And although there is a number of moving parts related to changes in payer mix and growth in exchanges, collectively we expect these changes will be a net positive for our business in 2014 and beyond.
We are participating in coverage expansion in both public and private exchanges. And as a PBM, we are participating in the public exchanges through our health plan clients on a carved-in basis, while the health plan offers integrated medical and pharmacy benefits and we provide the PBM benefits. In fact, our health plan clients’ footprint span 25 states covering nearly 70% of eligible exchange population.
Now, in the private exchanges, we are participating through both a carved-in basis as well as a carved-out basis as a standalone PBM, where we have direct prescription benefit offerings on the exchange products. We are also playing an important role in providing coverage to retirees through our Silver prescription drug plan as well as our health plan clients, PDP and MAPD businesses. It is also important to remember that our opportunities to participate are not limited it’s just the PBM, but stand across our entire enterprise to include our retail pharmacies and our MinuteClinic business. In particular, we expect that our retail business will benefit from the expansion of coverage in our ability to drive incremental prescriptions to our fixed cost structure. So, while there are a lot of moving parts, all things considered we are very well-positioned for this trend.
One of our truly unique aspects of our model is the ability to support health plans through our assets across our enterprise whether or not with the PBM. Our consumer expertise in this new business consumer world of healthcare is being welcomed by health plans across the country. Leveraging our retail footprint, we can support health plans market initiatives ranging from limited pilot marketing programs to full-scale educational programs. Some of these health plans, partnerships also include participation in preferred or restricted retail networks and many are taking advantage of convenient and affordable MinuteClinic services as well as cost savings PBM services and programs to better manage specialty pharmacy. While our strategy and reach will continue to grow and evolve the names listed on this slide are just a few examples of large national and regional health plans that are leveraging our enterprise capabilities even though they are not PBM clients.
So, with the implementation of the Affordable Care Act and the continued growth in Medicare, we are seeing a rapid increase in the number of consumers choosing their own health plans. This trend combined with continued cost pressures is driving rapid growth of consumer directed and high deductable health plans and as a result a push for greater value and transparency in the healthcare marketplace. Our advantage at CVS Caremark lies in the consumer-friendly channel-agnostic solutions that deliver greater value for both clients as well as their members.
We have a decade of experience in a business consumer environment and as a result we have a trusted plan and name recognition with both consumers and planned sponsors, which underscores our ability to capture share and win new business in the era of consumer driven healthcare. Our innovative channel-agnostic offerings such as maintenance choice and pharmacy advisor transform the value equation for PBM clients as well as their members delivering an unique combination of savings, quality as well as convenience and our ever growing footprint of convenient retail and MinuteClinic locations extend our reach with consumers. We have also invested significantly in new digital capabilities to enable strong multi-channel reach and integrated digital offerings and our low cost transparent pricing model at MinuteClinic will be especially attracted to cost conscious consumers seeking our greater values through our most cost effective channel of care.
Now, with so much change occurring in the broader healthcare marketplace, we are also seeing the economics of our business evolve. While some of our traditional sources of growth are beginning to slow, we expect strong growth in script demand to create a new opportunity for growth and share gains. Going forward, we believe the biggest and the greatest opportunities for EBIT growth will come from winning new lives and gaining the greater share of the consumers’ prescriptions dispensing volume. In terms of winning lives, we have been very successful in growing our PBM book over the – with the total adjusted claims up about 42% since 2008.
And importantly, now in addition to growing our overall PBM book of business, we have been very successful at gaining share of PBM client spend across our enterprise channels. Since 2008, PBM claims that are filled at the CVS Caremark channels meaning that they were either filled at CVS retail or Caremark mail are up 55%. That compares to the 42% growth in all claims in the prior slide. So, we are gaining share of the growing pie, which we see is the formulary for success. By combining our mail and retail capabilities, we can provide greater value and savings for our clients and their members while also maintaining an attractive economic result for CVS Caremark. And despite the progress we have made, we see significant opportunities to continue to grow share from an enterprise perspective of PBM client spend.
Now, before I wrap up, I will just touch on our continued commitment to enhancing shareholder value. Over the past three years, this has been our roadmap for driving value will remain our GPS going forward includes three main pillars. First is our focus on driving productive long-term growth, second is the expectation to generate significant levels of free cash and finally is our disciplined approach to capital allocation. In 2014, we expect to maintain our strong track record of successfully managing all three pillars. At our Analyst Day last December, we laid out a new step of steady state growth targets for the period of 2013 through ‘18. And over the course of the next five years, we are targeting compounded annual growth rates of between 9% and 13% on the top line, 7% and 9% in operating profit, and 6% to 8% in adjusted earnings per share. And over the quarter – and given this earnings progress plus continued improvements in capital management, we will have on average $7.5 billion to $8.5 billion annually of cash available to enhance shareholder value.
And assuming that a certain portion of this cash is used to repurchase shares through the period, we could enhance EPS growth by another 4% to 6% leading to a compounded annual growth rate of total adjusted earnings per share of 10% to 14% over the next five years. Along with these targets, we have also laid out our priorities for capital requirement over the next five years. 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, what are our priorities for this cash? First, we will make strategic investments that drive the long-term growth and financial returns of our business. Second, we set a targeted dividend payout ratio of 35% by 2018 versus our current level of approximately 24%. This implies a compounded annual growth rate in dividend of nearly 18%. And last, absent high return strategic investments perhaps $4 billion to $5 billion of annual value enhancing share repurchases could be executed.
Beyond providing 2014 guidance in Analyst Day, we also announced that our Board has approved an annual dividend in 2014 of $1.10 a share, up $0.20 or 22%. Additionally, our Board has approved a new $6 billion share repurchase program, which reflects our ongoing commitment to returning value to our shareholders. It gives us the ability to continue our successful buyback program. And with it, we expect to complete at least $4 billion of share repurchases through 2014 continuing on our recent pace.
So, in summary, I think you can see that we are very optimistic about the opportunities ahead for the company. We believe changes in the healthcare environment are creating significant opportunities for growth and we are focused on innovative solutions to better meet the changing needs of both our clients and our customers. Our unique model creates sustainable competitive advantages for us and real value for patients, customers and clients and this is how we will continue to win in the marketplace. We will continue to migrate towards a greater focus on enterprise growth defined by winning lives and capturing a greater share of pharmacy spend and hopefully, you understand that we are committed to enhancing shareholder value through strong earnings growth, substantial cash generation, and disciplined capital allocation.
So, with that, I thank you for your time this morning. And we probably have a couple of minutes, happy to take your few questions.
Peter Costa - Wells Fargo
Okay. We have time for few questions. You can text me your question if you want me to ask is track 4 to 22333 and I will be able to ask the question for you if you don’t want to ask it or just go ahead and ask and maybe I will start up with a question on utilization.
Peter Costa - Wells Fargo
We have seen a couple of your competitors post some pretty good monthly comp numbers in the second quarter here for April and May. And if you look at IMS script data, it looks like script volume is up. So, it looks like things are generally tracking quite well right now. Can you tell us I know you are not giving guidance on the second quarter, but can you tell us what you think is driving that higher utilization right now?
Yes, good question. I think we did expect that the Affordable Care Act would drive some level of utilization growth as we cycle into 2014 as we talked about at Analyst Day. And we do take the 2014 quite frankly as a transitional year from Affordable Care perspective that has – that while people are growing in the exchanges, it is unclear how many of those new enrollees are net new enrollees in the sense that they just trade one health plan off for the exchange product. So, I think the short answer is kind of hard to tell exactly how the utilization is – where the utilization is coming from at this point in time. We have seen expansion in the Medicaid roles. So, I think that’s a little bit more clear from a line of sight perspective. And again, we have talked about this at length at different points in time, but the most effective way to manage cost in healthcare system is to make sure people are taking their medication. And so I think there has been a real emphasis on that kind of throughout the environment in healthcare.
Two questions. (Question Inaudible)
Okay, great question. So let’s take the tobacco question first. Just we haven’t started selling yet, so we have announced our attention to stop selling them and so that will happen in the back half of the year. We have done this because we go out with clients in health plans and in numbers and we say trust us with your membership and if you trust us with your membership we can make sure that they are taking the medication appropriately, so that we can improve their healthcare. So it was really inconsistent with us on one hand to say trust us and we will take care of you and we will make sure that your patients become healthier. At the same time selling cigarettes and so I think that it was really inconsistent with our strategy so we – so now we are completely aligned with our payers, the people who are really buying the checks for prescription medication.
Secondly we have really also aligned with providers many of the physicians that we support day-in, day-out. They are trying to get their patients off of cigarette as well tobacco is really big driver for them, so we have been, I think we have aligned our mission with providers and aligned our mission if you will with the payers. So we believe that over time we will gain a larger share of those customers and those customers shopping in our channels that’s how we are going to make it up. And that’s not going to be instantaneous, it’s going to take some time for us to win those lives and to move that share.
And then secondly – I guess your second question is on sales and operating profit growing at different rates. We do believe that we are in a margin compression business and a price compression business, so we do believe that sales will grow faster than our operating profit and provide margin pressure on our business. I think that’s the reality in our world. And I would expect that to continue over the next several years. I don’t see a way in which absent quarter-over-quarter trend that could make that change, but the long-term trend is going to compression.
It is, probably a little more prevalent in the PBM business only because we are – the PBM business is taking on – has lower margins taking on they come in chunks if you will from a revenue capture perspective, okay.
Yes, we can the problem is on the touching that one first and on the front side of the house is if you look at the percentage of front compared to the totality of the business there it’s 15% of the total volume. So it’s hard to make up compression across 85% of the business, if a business is only 15%. I do think we have opportunities to improve the front store business, so there are big opportunities both in leveraging the ExtraCare program personalization, digital and private label all of which will help and fuel that to some degree but just not enough to offset it. So I think that’s number one.
Number two is if you look at what happened in the marketplace there are a couple of dynamics that are occurring. One is the generic tailwind was very prevalent in 2012 and 2013 as generic break over to generics were at their highest level over probably last decade or so. That tailwind was going to continue - is going to continue at lower rates, lower pace if you will if you look at the generic top line over the next five years. So you don’t have the same opportunity to move from a branded product to a generic product as aggressively, so that’s number one.
Number two, there is price compression in the marketplace as payers are asking for and looking for cost effective solutions to manage their prescription costs and so you see that reimbursement pressure on both sides of our business whether it will be PBM or whether it be retail. And the way to offset that is to improve your cost of goods sold and to ship more branded drugs into generic indications. And I think we just recently talked about we announced the formation of the joint venture with Cardinal Healthcare to help us on the generic procurement side of the house to lower our cost of goods sold. Those are the dynamics that are - and that’s why if you will.
Peter Costa - Wells Fargo
(Question Inaudible) 40% of the specialty spend comes under the medical benefits.
Peter Costa - Wells Fargo
What are you doing to address that and like how are you working with your health plan customers to sort of…
Yes. That’s a good question. I think right now if you look at specialty and totality is about 50-50 right now. About half of the business is paid for and adjudicated under the pharmacy business, about half of is paid for under the medical benefit. Under the medical benefit, we are coming at it kind of in a few different ways. First, we have recently acquired a technology called NovoLogix, which allows us to effectively and essentially in real time analyze drugs dispensed, specialty drugs that are dispensed within the medical benefit to understand both dosage and price outliers so that we can reprocess those claims and focus in areas to help the health plan kind of drive further savings there. So, that’s a big push for us. Secondly, we have just recently announced the acquisition of Coram, which is an infusion business. That infusion business is really providing – in many cases, providing specialty drugs that are billed under the medical benefit. So, that’s another way in which we are trying to address that market to some degree.
Peter Costa - Wells Fargo
I think we are out of time. Thank you all for coming and Dave, thank you very much for your time.
Dave Denton - Chief Financial Officer
No, thank you very much.
Peter Costa - Wells Fargo
Thank you all.
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