CVS Caremark's Dividend Increase And The Facts Behind It

| About: CVS Health (CVS)
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Starting in the next quarter CVS Caremark (CVS) will increase its quarterly dividend to $0.225 per share, payable February 4, 2013, to holders of record on January 24, 2013. The annual rate will become 90 cents per share, up from 65 cents. This is the tenth consecutive yearly dividend increase. The company's goal is to increase the dividend payout ratio from 25 percent to 30 percent by 2015. The increase in dividend has been made possible by the company's stellar performance.

Purchasing power

CVS Caremark has tremendous purchasing power.

It buys pharmaceuticals for its 7,400 drugstores, which serve about 5 million customers a day, and for a large Pharmacy Benefit Management (NYSEMKT:PBM) operation.

The PBM's clients are typically employers who are self-insured, governmental entities (i.e., state employees, military), unions, third party administrators, and managed care companies.

CVS's pharmacy share of the Pharmacy Benefit division has grown over the past 5 years from 18 percent in 2007 to more than 30 percent today. This significantly outpaces the growth in CVS pharmacy's overall retail market share. CVS is the largest provider and purchaser of prescriptions in the U.S., filling 1 billion prescriptions annually, about 25 percent more than its largest retail competitor and more than double the number sold by its largest PBM competitor. CVS drugstores also sell a wide range of products other than drugs, such as beauty products and cosmetics, films and photo services, foods including beverages and liquor, and various items for everyday use.

CVS has been running a large loyalty card business for the past 15 years and has 70 million active cardholders.

In 2012 CVS' largest competitor, Walgreen (WAG), had a contractual dispute with Express Scripts (ESRX), which lasted for a good part of the year but was eventually resolved. During the dispute, Walgreen's rivals like Rite Aid (RAD) and CVS scooped up a large portion of its customers, some of whom may never return to Walgreen.


CVS also runs an innovative chain of clinics, called MinuteClinics. In the third quarter of 2012 MinuteClinic revenues increased 43 percent versus the third quarter in the previous year. The company opened 25 new clinics and currently operates 609 clinics in 25 states. In 2013 another 150 are scheduled to open.

MinuteClinic is the largest and fastest-growing retail clinic chain in the country. The walk-in clinics are open 7 days a week with no appointment necessary. About half of the patients are seen on evenings and weekends when physician offices are closed and the only options would be costly emergency rooms or urgent care centers.

MinuteClinics have cared for 8 million patients in the last 3 years. The employees, 2,000 nurse practitioners and physician assistants, treat patients with both acute and chronic medical problems. Fifty percent of the patients do not have a regular primary care physician and this number is likely to increase as the primary care physician shortage worsens.

The 2012 revenue from the clinics will reach between $185 and $190 million. For 2013 the company expects a revenue of $225 million, up 20 percent from 2012. Among the services the clinics provide are physical exams, chronic disease monitoring, immunizations, and wellness programs such as weight loss and smoking cessation.

Massachusetts is an example of the need for this type of clinic. The state has the highest number of primary care physicians per capita, yet waiting times for primary care appointments continue to rise. Massachusetts is one of the fastest-growing MinuteClinic states. MinuteClinic has started out as an all-cash business but is now accepting 250 different commercial and governmental health plans, which cover about 85 percent of the visits. For the remaining uninsured and patients with high deductible health plans, the clinics offer low and transparent 2-digit prices.

For example, last spring, the clinics performed camp physicals for just $49. In the rest of the health care system this sum might only cover parking fees.

A survey found that MinuteClinic prices are generally 40-80 percent lower than alternative sites of care and equal in quality.

Long term cash management

CVS has a long term cash management plan in place, started in 2010. In the next five years CVS will generate about $31 billion in cash, between $5.5 billion and $6.5 billion each year. The goal for the dividend payout rate is set to increase to 25-30 percent by 2015 versus the previous level of about 13 percent.

What is the company's plan for cash use? First of all, it will try to invest in projects that will grow the business with good long-term returns. If no such projects are found, the cash would be returned to the shareholders.

How has this strategy worked in the past two years? The cash generated from earnings in 2011 and 2012 is more than $12 billion. CVS will reinvest about $3 billion back into the business, leaving $9 billion in free cash. By the end of 2012 the company reduced its outstanding debt by $1 billion, in an effort to reach an acceptable 2.7x leverage target.

Add to this $1.5 billion in proceeds the company has received from other activities, primarily from the exercise of employee stock options in the sale of the TheraCom business. In the past two years CVS had about $10 billion to allocate among dividends, acquisitions, and share repurchases.

The quarterly dividend has been increased by 86 percent in 2011 and 2012. The payout ratio is on target, presently at around 21 percent.

CVS acquired a couple of first-rate Prescription Drug Plan (NASDAQ:PDP) businesses that are already bolstering the company's performance in the Medicare Part D segment.

About $7 billion shares were repurchased in 2 years or $3.5 billion per year on average.

Over the next several years, CVS intends to continue with the plan.

Within five years, from 2011 through 2015, a total of $33 billion cash could be generated. Thirty percent of this cash will be invested back into operations. An additional $8 billion could be raised by issuing new debt, if needed, while maintaining the 2.7x debt to EBITDA leverage target. That means that over the coming 3 years CVS will have about $22 billion available to enhance shareholder returns.

Investor's summary

Guidance for 2012 forecasts earnings per share between $3.38 and $3.41 and free cash flow for the year of between $4.6 and $4.9 billion.

The company is taking advantage of the favorable interest rate environment and replacing several of the higher interest rate long-term notes by buying back up to $1.3 billion worth of notes. In 2013 the company expects to deliver earnings per share of $3.84 to $3.98, an increase of 13.25 to 17.25 percent. The company will generate a substantial free cash flow of $4.8 billion to $5.1 billion, and cash from operations of $6.4 billion to $6.6 billion.

This guidance assumes the completion of $4 billion in share repurchases during 2013. The guidance does not include the anticipated benefit from the company's recent debt tender and refinancing, which is expected to result in annual EPS accretion of approximately two cents thanks to the reduction of interest Expense.

For 2013, S&P Capital IQ projects total CVS sales to rise 4 percent, to $129 billion, from an estimated $124.1 billion in 2012, and way up from 2011's $107.1 billion.

In the past 52 weeks the stock price ranged from $40.78 to 49.80.

Conclusion: CVS Caremark is an aggressive and innovative company with a solid future.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.