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CVS Health Beats Q3 Earnings, Revenues; Narrows Outlook

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CVS Health Corporation (CVS) – formerly known as CVS Caremark – reported third-quarter 2014 adjusted earnings per share (EPS) of $1.15, up 9% year over year. The result also sailed past the Zacks Consensus Estimate by a couple of cents, while remaining ahead of the company-provided guidance range of $1.11 to $1.14 per share. This adjustment excludes loss on early extinguishment of debt in the reported quarter and the 2013 gain from the legal settlement. Without the one-time adjustments, reported EPS in the third quarter declined 20.5% to 88 cents.

CVS Caremark Corporation - Earnings Surprise | FindTheBest

Quarter under Review

Net revenue improved 9.7% year over year to $35.02 billion, beating the Zacks Consensus Estimate of $34.61 billion.

The Pharmacy Services segment revenues increased 15.7% to $22.5 billion in the quarter. The segment gained from growth in specialty pharmacy business – including the acquisition of Coram – as well as the impact of Specialty Connect and increased volume in pharmacy network claims.

Pharmacy network claims that were processed during the quarter edged up 4.3% to 209.6 million backed by net new business and growth in Managed Medicaid. However, decline in Medicare Part D claims partly hampered this growth.

Moreover, decline in traditional mail volumes, partially offset by growth in Maintenance Choice program, brought the Mail Choice claims processed to 20.7 million, down 1.3%.

Revenues from CVS’ Retail Pharmacy improved 3.1% year over year to $16.7 billion. Same-store sales increased 2%, while front-end same-store sales declined 4.5% year over year. Front-end same-store sales decline was attributed to softer customer traffic, partially offset by an increase in basket size. According to the company, excluding tobacco and the estimated associated basket sales, front-store same-store sales would have been approximately 480 basis points (bps) higher.

Pharmacy same-store sales increased 4.8% in the reported quarter. Despite generic introductions and implementation of Specialty Connect affecting sales by 190 bps each, CVS posted pharmacy same-store sales growth. Moreover, Pharmacy same-store prescription volumes rose 5.1% on a 30-day equivalent basis.

The generic dispensing rate (the proportion of all generic prescriptions to total number of prescriptions dispensed) soared 180 bps to reach 82.5% in the Pharmacy Services segment and 83.3% in the Retail Pharmacy segment.

Although gross profit increased 7.3% to $6.5 billion, gross margin contracted 41 bps to 18.5%. Operating profit for the Pharmacy Services positively increased 7.3% on the back of growth in specialty pharmacy and favorable purchasing economics, partially offset by price compression. Retail Pharmacy segment’s operating profit increased 4.3%, positively impacted by growth of prescription volumes combined with an improved pharmacy margin rate, partially offset by the loss of sales from tobacco and the associated basket as well as incremental store operating costs associated with operating more stores. However, total operating margin contracted 33 bps on 9% increase in operating cost.

CVS exited the quarter with cash and cash equivalents and short-term investments of $1.21 billion, down from $4.18 billion at the end of 2013. Net cash provided by operating activities for the year increased 11% to $4.71 billion.

During the third quarter, CVS opened 45 retail drugstores, acquired 33 and closed 4 existing ones. Further, the company relocated 13 retail drugstores.

As of Sep 30, 2014, CVS operated 7,935 locations, which include 7,779 retail drugstores, 936 health care clinics, 17 onsite pharmacies, 26 retail specialty pharmacy stores, 11 specialty mail order pharmacies, 4 mail service dispensing pharmacies and 84 branches and 6 centers of excellence for infusion and enteral services in 47 states, as well as the District of Columbia, Puerto Rico and Brazil.

Guidance

Following the end of the third quarter 2014, CVS narrowed the adjusted EPS guidance for 2014 to a range of $4.47 to $4.50 from $4.43 to $4.51. The current Zacks Consensus Estimate of $4.49 falls close to the upper end of the guidance range.

The company raised its 2014 free cash flow guidance to a range to $5.7 to $6.0 billion from $5.5 to $5.8 billion and upped the cash flow from operations guidance to a $7.4 to $7.7 billion range from $7.2 to $7.5 billion.

For the fourth quarter of 2014, the company expects to report adjusted EPS in the range of $1.18 to $1.21. The current Zacks Consensus Estimate of $1.21 coincides with the upper end of the range.

Our Take

CVS Health successfully posted another quarter of earnings and revenues beat. The Pharmacy Services segment was positively impacted by growth in specialty pharmacy growth in specialty pharmacy business – including the acquisition of Coram, while the Retail Pharmacy segment was positively impacted by increased same store sales.

We are upbeat on solid growth in the PBM segment, especially the growth of the specialty pharmacy business. Moreover, having generated strong free cash flow in the quarter, the company is confident of achieving its 2014 goals.

CVS continues to benefit from the introduction of generics that pushed profits higher. The 2015 PBM selling season continued to be strong with a significant number of new business wins across all lines of business.

Currently, the stock carries a Zacks Rank #3 (Hold). Some of the better-placed stocks in the broader Medical sector are Abaxis, Inc. (ABAX), Boston Scientific Corporation (BSX) and ICU Medical, Inc. (ICUI), all carrying a Zacks Rank #2 (Buy).

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