Sustained Performance In The Future And Growth In The Top Line Make CVS A Buy

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 |  About: CVS Health Corporation (CVS)
by: Equity Watch

Summary

The company’s healthy financial performance will be driven by retail segment’s and PBM segment’s growth.

Continues to grow top-line numbers in competitive U.S. pharmacy market.

Has been consistently sharing success with shareholders through share repurchases and dividends.

I reiterate my bullish stance on CVS Caremark (NYSE:CVS); the company reported healthy results for 2Q14, beating analyst revenue and EPS expectations. Despite the generic drug cost inflation, CVS' venture with Cardinal Health has kept the generic cost burden low, which is positively affecting its margins. I believe the consistent growth in the number of enrollees under the ACA and Medicaid extension, combined with the increased usage of specialty drugs, will support the company's top-line growth in the future. Also, the company remains committed to sharing its success with investors through share repurchases and dividends, which makes it a good investment for dividend investors.

Top-Line Growth = Strong PBM

Despite the price competition in the healthcare sector, CVS reported another quarter of healthy top-line growth due to the ongoing improvements in the PBM segment. The overall revenue of the company grew 10.7% year-over-year in 2Q14. The company's PBM segment's revenue was up 16% year-over-year, which will increase shareholder confidence. Moreover, the Medicaid extension, which has been a key driver for the PBM segment's revenue growth, adds towards the segment's growth potential. As the company grew its Medicaid-managed organizations in 26 states, its Medicaid business reached 6.7 million individuals, up 3 million year-over-year in 2Q14. I believe the ongoing Medicaid extension will keep on fueling the company's top line in coming quarters.

Furthermore, other than the Medicaid extension, another major driver of the PBM segment's growth remains an increase in specialty drug usage. The specialty revenue during the quarter was up 53% year-over-year. CVS rolled out its Specialty connect offerings during the quarter, giving enhanced clinical support as a result more than 60,000 patients transitioned to the company's specialty service model. During the 2Q14 earnings conference call, the management clarified its plans to keep on growing its specialty pharmacy share. The CVS CFO said:

"We remain optimistic that we can continue to gain specialty pharmacy share, as we work to develop innovative offerings that capitalize on our unique ability to optimize cost, quality and access."

Moreover, the company's acquisition of Coram stays on track and is expected to add $1.4 billion during the first twelve months of integration. Also, the acquisition will fuel specialty revenue growth for CVS. Furthermore, the company's newly introduced drug for Hepatitis C patients, "Sovaldi", also contributed to the current quarter's revenue growth. The drug got immense popularity, proving effective on 10 out of 9 Hepatitis C patients. Also, the company has ensured that its management is working to lower down the cost of Sovaldi to make it more affordable, which I believe will fuel top-line growth for the company.

Margin Expansion

In the past few quarters, the North American healthcare sector inclined towards high-margin generic products. With the increase in generic drugs usage, retail chain companies ramped up their efforts to improve their generic drug purchasing power in the industry. In this attempt, CVS contracted with Cardinal Health so the company could have greater purchasing power. Due to the Cardinal Health joint venture, the company has developed a superior ability to buy generics as compared to its peers, which will keep the generic cost burden low for CVS. In 2Q14, due to better purchasing power and lower costs, CVS' operating margin grew 6bps year-over-year. I believe the company's margins will improve in the coming quarters due to the introduction of generic drugs and better purchasing power.

Bottom Line

The stronger-than-expected top-line results for CVS in 2Q14 helped the company report an earnings beat for the quarter. The company reported an EPS of $1.13 for 2Q14, up 16.5% year-over-year, beating analyst estimates by 2.70%. Based on its strong potentials for FY14, the management expects stronger earnings from CVS. The company recently increased its earnings guidance for FY14 from $4.36-$4.50 to $4.43-$4.51. Moreover, analysts also expect stronger earnings growth for the company in the coming years; analysts are anticipating a healthy next five years growth rate of 13.33% for CVS, as shown in the chart below.

Source: Nasdaq.com

Value Creation

CVS has been consistently sharing its success with investors through constant share repurchases and dividends, which are supported by its healthy cash flows. In 2Q14, a strong selling season boosted the company's top line and grew its cash flows. The company currently offers a modest dividend yield of 1.4%, backed by its strong free cash flow yield of 4.5%. I believe the company's strong growth potentials will keep on adding to its cash flow base, portending well for its ability to pay dividends in the coming quarters.

Moreover, the company has an ongoing share repurchase program to keep up with investor expectations. The company repurchased approximately $1.2 billion and $2.0 billion worth of common shares in 2Q14 and 1H2014, respectively. Also, the company can repurchase $4.7 billion worth of common shares under its ongoing share repurchase program. I believe the share repurchases will help the company grow its EPS and magnify ROE.

Conclusion

I believe CVS will continue to deliver a healthy financial performance in the future, primarily driven by its retail segment's and PBM segment's growth. Also, benefiting from the ACA, the company continues to grow its top-line numbers in a competitive U.S. pharmacy market. Also, due to higher generic drug usage and better purchasing power, the company will be able to improve its margins. Moreover, the company has been consistently sharing its success with shareholders through share repurchases and dividends. Due to the aforementioned factors, I am bullish on CVS.

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.