Recently, we reiterated our Neutral recommendation on CVS Caremark Corporation (CVS) with a target price of $47.00.
CVS Caremark reported first quarter 2012 EPS of 59 cents, up 13.5% year over year. However, after excluding the impact of certain one-time items from both the periods, adjusted EPS came in at 65 cents, surpassing the Zacks Consensus Estimate of 63 cents and up 14.0% year over year. Net revenue during the quarter increased 19.9% year over year to $30.8 billion, marginally beating the Zacks Consensus Estimate of $30.4 billion.
CVS is gradually witnessing strong performance in the field of Pharmacy Services. After a sluggish phase, the company has delivered improved performance in this segment for the fifth consecutive quarter. Moreover, we are encouraged to note that the company already completed 25% of its contract renewals scheduled for 2013.
For the past few quarters, CVS maintained a high retention rate (completed the last reported quarter with 98%). We expect CVS to continue with this growth trajectory even in the forthcoming period. For fiscal 2013, CVS estimates total contract renewal of $14.5 billion.
The company is also confident of achieving margin expansion in 2012. One of the primary reasons for this assumption is the huge potential of generic drugs. The amount of branded drugs expected to go off-patent in 2012 will be more than double than that recorded in the past five years. Moreover, benefits from the company’s streamlining initiatives are expected to outweigh related costs in 2012.
The company is also planning to emphasize on its key-growth areas such as Universal American's PDP Businesses, Maintenance choice and Pharmacy Advisor programs and the rapidly growing Specialty Pharmacy sector.
CVS also maintained its strong performance in the Retail segment with an 8.4% increase in same-store sales. This huge retail growth significantly benefited from the company’s record market share gain following the termination of the Express Scripts Holding Company (ESRX) - Walgreen Co. (WAG) retail contract. The impasse between the two big players led to a 9.8% in CVS’ pharmacy same-store sales. CVS also anticipates a benefit of roughly 3 cents to 4 cents in the second quarter of 2012 from the non-renewal of the Walgreen and Express Scripts contract, which is encouraging.
The company now expects the company’s fiscal 2012 Retail Pharmacy’s operating profit to increase 10.5%–12.5% (8.5%–10.5%) while that of the Pharmacy Services remained unchanged at 11%–15%. The company reiterated its 2012 free cash flow and cash flow from operations guidance of $4.6–$4.9 billion and $6.2–$6.4 billion, respectively.
However, despite implementing diverse strategies to expand its business, CVS continues to face margin pressure. Gross margin during the reported quarter decreased 185 basis point (bps) year over year to 16.6%. Moreover, operating margin contracted 50 bps to 4.6%.
Moreover, the recent merger between Express Script and Medco has thrown more challenges for CVS in the Pharmacy Services segment. The deal combined two of the three largest US drug benefit managers and created a dominant player in the Pharmacy benefit Management (PBM) space that will cover more than 150 million prescription drug consumers and 50% of the large employer market.
Consequently, we remain apprehensive based on the huge and growing market leading capacity of the merged entity compared to CVS.
We remain Neutralon the stock as we believe that most of the positives are offset by the negative catalysts. The stock also carries a Zacks #3 Rank (short-term Hold
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