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Recently, we reiterated our Neutral recommendation on CVS Caremark Corporation (CVS - Analyst Report) with a target price of $46.00.

CVS reported adjusted EPS of 89 cents in the fourth quarter of 2011 in line with the Zacks Consensus Estimate and 12.6% higher than the year-ago quarter. For the full year, adjusted EPS rose 4.5% (5.9% excluding 2010 tax benefit) to $2.80, also matching the Zacks Consensus Estimate.

CVS is gradually witnessing strong performance in the field of Pharmacy Services. After a sluggish phase, the company has exhibited improved performance in this segment for the fourth consecutive quarter and has started off the 2012 selling season on a positive note. With 90% of the contract renewals scheduled for 2012 already complete at the end of fiscal 2011, CVS’s retention rate was as high as 98%.

New business wins stood at an encouraging level of $7.2 billion (significantly up from the $6.8 billion as provided on its Analyst Day on January 10, 2012). The company also won some new accounts, which led to an increase in estimate for the number of new Medicare Part D lives for 2012 to 200,000 lives, thus bringing the company’s Medicare Part D prescription drug plans (PDP) lives up to approximately 3.6 million to date.

The company also expects another $5.5 billion in new business wins associated with the PDP acquisition from Universal American in 2011 and Universal American's (UAM - Snapshot Report) Medicare Advantage plan.

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, Aetna and the rapidly growing Specialty Pharmacy sector.

CVS also maintained its strong performance in the Retail segment with a 2.5% increase in same-store sales, which touched the top end of its guidance range (0.5%−2.5%) leading to a 4.0% climb in retail revenues.

However, despite implementing diverse strategies to expand its business, CVS continues to face margin pressure. Gross margin during the reported quarter decreased 258 basis point (bps) year over year to 19.6%. Moreover, operating margin contracted 60 bps to 6.9%.

In addition, the proposed merger between Express Script (ESRX - Analyst Report) and Medco is expected to further challenge CVS in the Pharmacy Services segment. The deal is expected to combine two of the three largest US drug benefit managers and create a dominant player in the PBM space that will cover more than 150 million prescription drug consumers and 50% of the large employer market.

Together with CVS, they are expected to cover approximately 240 million prescription drug consumers. Consequently, post-merger, even CVS would not be able to stand in competition with combined entity. We expect the merger to create market concentration in the entire economy, leading to an anti-competitive landscape for CVS.

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