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Summary

  • Company continues to grow and report healthy financial performance.
  • The positive performance primarily driven by growth in PBM and retail segments.
  • Decision to stop tobacco sales will pay off in long term.

I reiterate my "buy" rating on CVS Caremark pharmacy (NYSE:CVS). The company's pharmacy benefit management [PBM] segment, backed by its competitive pricing policies and more enrollments under the Medicaid program, continues to uplift its top-line results. Moreover, the PBM segment will keep on growing the company's top-line and bottom-line results, with the continuous implementation of the Affordable Care Act (ACA) and Medicaid expansion. Furthermore, the retail segment of CVS stays on track for decent growth in the future. Going forward, the stock will benefit from CVS's decision to cut off tobacco sales and enter into a joint venture with Cardinal Health.

CVS, the second largest drug store retailer in the U.S., along with its subsidiaries, provides pharmacy healthcare services through its 7,700 drug stores. The company stands at a dominant position among the key drug store peers in the U.S.

Financial Highlights

The company's large, growing and highly productive PBM segment has been playing a vital role in growing its top-line results. CVS, through its PBM segment, is well catering the price based competition in the sector. The company's competitive pricing initiatives coupled with specialty and net new business resulted in a strong recent quarter financial performance for this sector. CVS recently reported $20 billion revenue for the PBM segment in 1Q2014, up 10.3% year-over-year. Moreover, the segment also outperformed the management's expectation with its operating profit growth of 28.5%.

Another key driver for the impressive top-line results of PBM business was Medicaid. Up till now, the CVS Medicaid business, with its coverage to 3 million people, positions the company well with a 28% market share. The management's expectation to keep up its leading position in Medicaid through continued transition from fee-for-service into managed Medicaid and from new enrollees of ACA will drive revenue growth in future.

Despite the headwinds of a less severe flu season and the company's policy of not responding to aggressive promotions by its peers, CVS' retail segment continues to report decent growth for its top-line and bottom-line results. Revenue for the segment increased 2.7% year-over-year. Moreover, the retail operating profit also registered an impressive growth of 14.2% year-on-year in the quarter. The company has been fueling retail segment growth through incremental retail prescriptions generated by growth in its store base, continued improvements in serving customers and significant share gains from WAG. CVS's management plans on continuing this growth formula in the long run, which makes me believe that the management guidance of 4% and 6.5% increases in revenues and operating profit for the year, respectively, are attainable.

Solid performances of PBM and the retail segment fueled the company's earnings growth in the recent quarter; the company reported an increase of 22.5% year-over-year in its adjusted EPS. Moreover, the management expects to deliver an EPS of $4.47 for FY14.

Affordable Care Act

All the drug chains in the U.S. have welcomed the ACA initiative by President Obama, as the initiative now draws more doctors' office activities towards drug stores. With the ACA expanding to 30 million Americans, CVS continues to believe that the program will act as a structural tailwind for the rapid growth for the company. As the ACA is now fully rolled out, companies in the industry are looking for new ways to improve the healthcare value equation. CVS has well positioned itself to thrive in this challenging environment, as the company announces greater focus on cost and quality, which will portend well for its future performance. These improved economies from the ACA will add to volume growth and ultimately help the expansion of the company's sales base in the long run.

No to Tobacco

The company has made a big move by deciding to cut off tobacco sales in its drug stores. In a world where people are increasingly becoming health conscious, I believe CVS's 'no to tobacco' sales are indeed a very smart move. Doing the right things always come at a cost, so CVS will have to bear a hit of $2 billion on its sales, as per the management's estimates. The initiative will align the company's interest with its clients.

Cardinal Health Care Venture

Over the past few quarters, pharmacies are largely been expanding their margins through sale of generic drugs, which are cheaper than branded drugs. The generic drugs, being low priced, offer high margins, approximately 50% higher than branded drugs. CVS's recent venture with Cardinal Health will benefit the company by lowering its cost of goods sold, thereby boosting the procurement of generic drugs by the company. I believe the venture will portend well for CVS's long-term profitability.

Conclusion

I am bullish on CVS; the company is continuously growing and reporting a healthy financial performance, driven by growth in both PBM and retail segments. The company is on track to grow its sales base in a highly competitive U.S. pharmacy sector, largely benefiting from the ACA. Moreover, the company's improving margins are also going to get a lift from its initiative to boost the procurement of generic drugs. Furthermore, the company's decision to stop tobacco sales is also going to pay off well in the long run.

Source: Competition In Pharmacy Sector Fails To Dampen CVS's Spirit