Investors in CVS Caremark (NYSE:CVS) continue to be pleased with their investment, seeing very strong returns amidst very healthy operating performance.
The very strong operating performance has been rewarded with shareholders pushing up the share price at a factor of nearly two since the start of 2012. This has pushed up the valuation toward a modest premium versus the rest of the market.
As such I like the company but will only buy the stock at a valuation roughly similar to the market, which I peg around $70 per share.
Second Quarter Highlights
CVS posted second quarter revenues of $34.60 billion, a 10.7% increase compared to last year. Reported revenue growth has been very strong with topline sales beating consensus estimates at $33.52 billion by more than a billion.
The company saw earnings growth essentially in line with revenue growth. Earnings were up by 10.9% to $1.25 billion. The company has repurchased roughly 5% of its outstanding share base over the past year, boosting earnings per share to $1.06.
Adjusted earnings which exclude amortization charges related to past acquisitions came in at $1.13 per share. This was three cents better than anticipated.
Looking Into The Results
The pharmacy services segment once again drove the results, posting a 16.2% increase in sales toward $21.8 billion. Growth in specialty pharmacy services, the acquisition of Coram, drug inflation and the mix all added to reported growth. The unit processes 210.4 million network claims, a 2.2% increase from last year. Operating earnings of the unit rose by 30% to $878 million for relatively modest operating margins of 4.0%.
Retail pharmacy revenues rose by 4.5% to $16.9 billion. Same store sales were up by 3.3% driven by pharmacy sales while front store comparable sales were actually down by 0.4%. These sales would have been down by 1.2% if it were not for the shift in the Easter holiday this year. It should be noted that the elimination of tobacco sales hurt sales by 110 basis points this year. Pharmacy sales results were hurt again by a further increase toward generic medication. On the bottom line, operating earnings advanced by 6.5% to $1.70 billion, resulting in operating margins just north of 10%.
Overall gross margins came in at 18.3% of sales a 40 basis point reduction compared to last year. Operating earnings totaled 6.4% of total sales, a 10 basis point improvement thanks to lower operating costs.
The unfavorable developments in gross margins result from faster growth at the PBM business which carries much lower margins. At the same time, operating costs of PBM are much lower as well, explaining the decline in operating costs.
Healthy Full-Year Guidance
For the full year, CVS now sees GAAP earnings or $4.16 to $4.24 per share, an upward revision from previous guidance for earnings of $4.09 to $4.23 per share.
Underlying this growth is an anticipated net revenue growth of 8 to 9% which should push sales toward $137-$138 billion for the year.
As should be no surprise the pharmacy-benefit operations are expected to drive growth with sales seen up by 13.75-14.25%. Revenues at the retail business are seen up by just 1.25-2.0%.
At the end of the quarter CVS held about $1.7 billion in cash and equivalents as well as short-term investments. Total debt of $13.4 billion results in a net debt position of about $11.7 billion at this moment in time.
With some 1.17 billion shares outstanding, and shares trading around $76 per share, equity in the business is valued at about $89 billion. On a trailing basis, the business has posted sales of nearly $135 billion on which it has posted net earnings of about $5 billion. This values the equity at a little less than 0.7 times sales and roughly 18 times earnings.
A History Of Growth
CVS has shown remarkable growth over the past decade, growth which has been aided by both acquisitions as well as organic growth. After reporting sales of just $30 billion in 2004, trialing revenues now total $135 billion. This kind of topline growth is remarkable as profit margins have been largely stable. As sales have increased by a factor of 4-5, the total outstanding share base has increased by some 40% over this time period. Note that the share base peaked at 1.45 billion shares in 2009. From this moment in time, CVS has repurchased roughly a fifth of its outstanding share base again.
Organic growth has been supported by population growth, drug price inflation and an aging population. Yet the big jump in sales was attributed to the $21 billion acquisition of Caremark in 2007, buying the pharmacy benefit manager to operate next to its core drugstore operations. It is this unit which continues to show the biggest revenue gains at this moment.
Other deals have been the 2008 $3 billion acquisition of Longs Drug Stores to further increase its drug stores in California. Just last year, CVS announced the acquisition of Coram which runs a drug infusion business for little over $2 billion.
CVS continues to move along just fine and this has resulted in shareholders attaching a valuation which is at par or represents a modest premium versus the wider market.
While shares have largely been trading in a $25-$40 region for the period of 2005 until most of 2012, shares have been on fire thereafter. The resulting growth under the Affordable Care Act and lack of disastrous effects on the profitability. Combined with lower interest rates and the huge stock market rally in the meantime has resulted in shares to double over the past three years.
Strong cash flows allow for high payouts to investors as well in the meantime. While the company's 1.5% dividend yield is not very high, the pace of share repurchases certainly is. The targeted $4 billion in share repurchases for this year results in a 4.5% yield to investors, for a combined ¨yield¨ of 6%.
The size and stability, combined with very healthy operating performance, is comforting to investors. Not only has the absolute performance been great, the relative performance versus the likes of Walgreen (WAG) and Rite Aid (NYSE:RAD) has been very good. Shares of its competitors have been falling around 20% in recent weeks amidst operational difficulties, profit taking or the disappointment with the lack of an inversion move in the case of Walgreen.
As such I keep the multi-year momentum in mind, which has largely been warranted given the operational performance, yet share price advancements have outpaced growth in real operations to some extent. As such, the company is a world-class business, yet that does not automatically translate into a world-class investment in current times.
As such I remain a bit cautious, buying into shares at this point in time. Perhaps a modest sell-off toward $70 per share with shares trading at 16-17 times earnings might provide me with a great entry point.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.