CVS Caremark (CVS) has made some incredible strides in its business over the last few years, and despite a share price that has performed very well, the stock doesn't get a ton of coverage.
A decade of strategic pharmaceutical acquisitions by CVS has put the company in a very strong competitive position. I can attest to the gain in PBM (pharmacy benefit management) market share that CVS has enjoyed in recent years.
In my hometown there are two CVS/Pharmacies. In either of these locales, you will find a very busy store-back, where the pharmacy is located. The local, family-run pharmacy just recently went out of business as a result of CVS' operations. CVS has deeper inventories, qualified staff, lower prices, and quick fills; that's what economies of scale will do for you.
This dynamic seems to be playing out all over the country. Local pharmacies clearly can't compete with resources that major players PBMs like CVS have at their disposal, and CVS' strong brand name and front-store sales are significant sources of profitability.
Demographics: A Major Driver Of Pharmaceutical Sales
While the entire U.S. population purchases pharmaceuticals, CVS' target market is the elderly, which I'll define as age 60 and up for purposes of utilizing U.S. census data.
From the 2010 census:
- The population of Americans aged 62 and older grew 21% from 2000
- There were 57 million Americans aged 60 and older
- 75 million Americans are projected to be 60 and older by 2020
- 92 million Americans are projected to be 60 and older by 2030
- 112 million Americans are projected to be 60 and older by 2050
With such an explosion in the elderly population, CVS has a gigantic, natural, growing market for its services.
As a low-cost, hands-on integrated healthcare services company, CVS will not only benefit from demographic shifts, but from gains in market share.
Competitive Advantages And Industry Dynamics
With local pharmacies rapidly being run out of business by the majors, we are left with the following players:
Wal-Mart (WMT), online drugstores, and a few other minors round out the industry.
CVS in-store pharmacists help senior citizens "navigate" the Medicare Part D prescription plan, and with Medicare spending expected to rise 8.5% annually over the next decade (according to CVS' Annual Report), CVS has the most to gain. The integrated approach that CVS offers is far more desirable than online drugstores or competitors without similar offerings.
Additionally, CVS' MinuteClinic is an interesting alternative for various healthcare services. The company expects to operate 1,000 MinuteClinics by 2016, most of which are in-store. Given the lower overhead, economies of scale, and synergies between CVS' PBM business and the clinic, MinuteClinic offers far lower prices and quality healthcare solutions to cost-conscious customers.
Revenue from MinuteClinic increased 17% in the second quarter.
Performance And Dividend
Revenue reached a record $107 billion in 2011, up 12% from 2010. FCF was up 39% from 2010 to $4.6 billion, and the company believes it is on target for $4.9 billion in FCF for 2012.
With the company opening about 140-150 stores a year, strong retention rates in the PBM business (98%), and strong demographic trends, the company should be able to achieve low double-digit EPS growth over the next several years.
For 2012, the company expects to earn $3.12 on a GAAP basis, resulting in a P/E of 14.2 - a discount to the broader market multiple of 16. Free cash flow per share is higher than EPS, meaning normal accounting standards understate CVS' true economic profits. Based on FCF, CVS is trading at a ratio of 11.4.
The 5-year annual growth rate for the dividend is 22%, and last year's increase was 43%. The current yield is 1.40%.
The company is aiming for a payout ratio of 30% (based on earnings, not FCF) by 2015. When considering that EPS is bound to be far higher in 2015 (probably near $4.50), we can expect an annual dividend of about $1.20 to $1.35 per share, or a reasonable 2.80% based on the current share price of $44.
Looking further out, CVS' strong FCF and share buybacks should allow for continued double-digit dividend increases and accelerated total returns.