CVS Health Corporation’s (CVS Quick QuoteCVS - Free Report) second-quarter 2017 adjusted earnings per share (EPS) of $1.33 were up a nominal 0.8% on a year-over-year basis. The quarter’s adjusted EPS also exceeded the Zacks Consensus Estimate by 2 cents.

Earnings performance was sluggish year over year on disappointing Retail/LTC numbers as well as weaker margins.

Without the one-time adjustments, reported EPS from continuing operations in the first quarter surged 24.4% year over year to $1.07.

Net revenue in the quarter increased 4.5% year over year to $45.7 billion and exceeded the Zacks Consensus Estimate of $45.3 billion by a close margin. Strong revenue growth in Pharmacy Services segment was partially offset by a decline in Retail/LTC performance in the quarter.

Quarter in Details

Pharmacy Services revenues increased 9.5% to $32.3 billion in the reported quarter, driven by growth in the specialty pharmacy volume, higher pharmacy network claim volume as well as brand inflation. This was, however, partially offset by increased generic dispensing and price compression.

Pharmacy network claims processed during the quarter climbed 10.3% to 376 million on a 30-day equivalent basis, backed by net new business growth. Also, the Mail Choice processed claim count was 65.6 million, up 5.2% on a 30-day equivalent basis on the continued adoption of Maintenance Choice offerings and a rise in specialty pharmacy claims.

Revenues from CVS Health’s Retail/LTC dipped 2.2% year over year to $19.6 billion, primarily due to a 2.6% decrease in same store sales, continued reimbursement pressure and an increase in the generic dispensing rate.

Front-end same-store sales were down 2.1% year over year. The shift of the Easter holiday to second-quarter 2017 from the first-quarter 2016 had a 75 bps positive impact on Front-end same-store sales. Front-store sales were, however, affected by soft customer traffic and efforts to rationalize promotional strategies, which were again partially offset by an increase in basket size.

Pharmacy same-store sales also declined 2.8% in the reported quarter. Sales were affected approximately 410 bps due to recent generic drug introductions. Also, Pharmacy same-store prescription volumes were flat on a 30-day equivalent basis. This apart, marketplace changes that restricted CVS Pharmacy from participating in certain networks had a 460 bps negative impact on same store prescription volumes.

The generic dispensing rate (the proportion of all generic prescriptions to total number of prescriptions dispensed) soared 130 bps to 87.2% at the Pharmacy Services segment and 150 bps to 87.6% at the Retail/LTC segment.

While gross profit dropped 1.1% to $6.9 billion, gross margin contracted 86 bps to 15.2%. Total operating margin during the quarter contracted 76 bps to 4.6% on a 10.2% plunge in operating profit.

CVS Health exited the quarter with cash and cash equivalents and short-term investments of $2.2 billion compared with $2.3 billion at the end of first-quarter 2017. Year to date, net cash provided by operating activities was $5.5 billion, up 34.1% from the year-ago period.

During the second quarter, CVS Health opened 27 new retail stores and shut three retail locations. Further, the company relocated 10 retail stores. As of Jun 30, 2017, CVS Health operated 9,700 retail stores, including pharmacies in Target stores across 49 U.S. states as well as the District of Columbia, Puerto Rico and Brazil.

2017 Outlook

CVS Health has narrowed its 2017 adjusted EPS guidance to $5.83-$5.93 from the earlier band of $5.77-$5.93.The Zacks Consensus Estimate of $5.87 is within this guided range. However, full-year operating cash flow guidance has been reiterated in the range of $7.7–$8.6 billion and free cash flow in the range of $6.0–$6.4 billion.

For the third quarter, the company expects to deliver adjusted EPS of $1.47-$1.50. This projection takes into consideration the timing of the Medicare Part D operating profit between the third and fourth quarters, relative to the preceding year. The current Zacks Consensus Estimate for the third quarter is pegged at $1.62, way above the company’s projection.

Our Take

CVS Health posted better-than-expected second-quarter results with both adjusted EPS and revenues beating the Zacks Consensus Estimate. However, poor year-over-year Retail/LTC numbers along with margin debacle resulted in a dull earnings performance by the company in the quarter.

Nonetheless, year-over-year growth on the top line was due to a strong Pharmacy Services segment, benefiting from the upside in the Specialty Pharmacy. An unimpressive bottom-line scenario also prompted the company to narrow its earnings outlook for 2017.

Zacks Rank & Key Picks

CVS Health has a Zacks Rank #3 (Hold). A few better-ranked medical stocks are Edwards Lifesciences Corp. (EW Quick QuoteEW - Free Report) , INSYS Therapeutics, Inc. and Align Technology, Inc. (ALGN Quick QuoteALGN - Free Report) , all sporting a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Edwards Lifesciences has a long-term expected earnings growth rate of 15.2%. The stock has gained around 5.9% over the last three months.

INSYS Therapeutics has a long-term expected earnings growth rate of 20%. The stock delivered a stellar four-quarter average earnings surprise of 60.7%.

Align Technology has expected long-term adjusted earnings growth of almost 26.6%. The stock has surged roughly 25.9% over the last three months.

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