Retail pharmacy companies, including CVS Health (NYSE:CVS) and Walgreens Boots Alliance, Inc. (NASDAQ:WBA), will deliver healthy performance in the upcoming quarters, despite weakness in front-end sales. CVS Health's compelling stock valuation makes it an attractive long-term investment for investors. The stock is down almost 9%, since hitting a year-to-date high of nearly $106 in May 2016. I believe investors' concerns regarding PBM contract losses and margin pressure are priced in. Therefore, the pullback provides a good entry point to initiate a buy position; the stock is trading at a forward P/E of 14.5x, versus WBA's forward P/E of 17x. In the upcoming quarters, CVS' performance will benefit from revenue synergies as a result of cross-selling infusion and institutional pharmacy. Moreover, the company will continue to share its success with the investors through cash returns, including share buybacks and dividends, which will augur well for the stock valuation.
Performance and Growth Catalysts
The aging of the U.S. population will bode well for the retail pharmacy companies, including CVS. In the U.S., about 3 million people are in need of specialty treatment, and given CVS management's increased focus on specialty health business, the company is positioned well to benefit from this opportunity. Also, CVS has a dominant market position in the specialty pharmacy market, which will support its future financial performance. Moreover, improvement in the PBM business will strengthen its revenues and cash flows. The PBM new business wins in 2016 are evident from its retail script trend and offer consistent growth opportunities; the company's revenues for 1Q16 grew by 18.9%, driven by robust growth of 20.5% in pharmacy service revenues. The company expects an incremental $400 million in net new business in 2016.
Also, its cost-cutting efforts will support bottom-line growth, and synergies from the recent acquisitions will help cost savings. The $12.7 billion acquisition of Omnicare will further strengthen CVS' position in the fast-growing specialty market, and the acquisition will add $0.20 to its EPS in 2016. Moreover, the strategic acquisition of Target's (NYSE:TGT) pharmacy and clinic business will allow CVS to expand its presence across the U.S. by expanding into new markets like Denver, Portland and Seattle.
In 2Q16, CVS lost PBM contracts for General Electric (NYSE:GE) and California Public Employees' Retirement System to UnitedHealth Group's (NYSE:UNH) OptumRx. I do not think the recent contract losses will drive any significant change in the PBM market, and CVS will stay competitive in the PBM market. PBM contracts do shift among different companies, and there is a possibility that CVS can get the contracts back; OptumRx will be the third different PBM service provider that California Public Employees Retirement System has had in almost last ten years. I recommend investors to keep track of the company's 2Q16 earnings release next month, as it will provide an update on its PBM contracts. I expect the company will have incremental business wins to at least partially offset the recent contract losses; CVS added more than $35 billion of net new PBM business in the last six years. And the company's integrated business model will continue to remain a major growth driver.
Moreover, the company's opportunistic debt refinancing in 2Q16 augurs well for its future EPS growth. The company took advantage of the ongoing favorable interest rate environment and issued $3.5 billion of debt to retire higher coupon notes worth of $3.1 billion, which will decrease its interest expense.
Furthermore, the stock valuations stay compelling for CVS, as it is trading at a forward P/E of 14.5x, in comparison to WBA's forward P/E of 17x. Also, CVS has a PEG ratio of 1.12, as compared to WBA's PEG ratio of 1.4, which indicates the company offers cheaper growth. CVS is expected to deliver low to mid double-digit EPS growth in the long term. Moreover, the company's cash flow generation remains strong, and will continue to improve with the growth in its PBM business; strong growth in the PBM improved the company's cash conversion cycle to 23.9 days in 1Q16 from 24.4 days, and the improvement is expected to continue in the second half of 2016. Moreover, the company will continue to share its success with shareholders through cash returns, which makes it attractive investment prospect for income investors.
The company is executing its strategy well and its business fundamentals stay strong which will support its long-term growth. The PBM business will continue to support its retail segment's growth in the future years. Also, as the company will continue to achieve synergies from the recent acquisitions and benefit from cross-selling revenue synergies, its earnings growth will remain strong. Moreover, the company's strong cash flows will allow it to share its success with shareholders through dividends and share buybacks. Also, the recent pullback in the stock price provides a good entry point to initiate a buy position in CVS.
Disclosure: I/we 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.