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Strong 1Q for CVS, Guidance Up

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CVS Caremark (CVS - Free Report) 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, beating the Zacks Consensus Estimate of 63 cents and 14.0% higher than the year-ago quarter.  

Net revenue during the quarter increased 19.9% year over year to $30.8 billion, beating the Zacks Consensus Estimate of $30.4 billion.

The robust increase in the company’s earnings during the quarter was primarily on the back of an 18.4% increase in operating profit in its Retail Pharmacy segment that considerably benefited from the termination of Express Scripts (ESRX - Free Report) -Walgreen retail contract.

Additionally, an extra day due to the leap year combined with Maintenance Choice program gaining further momentum also contributed to the improvement in the company’s bottom line. Moreover, accountings change (effective January 1, 2012) for the prescription drug inventories of CVS’ Retail Pharmacy segment resulted in an after tax benefit of one cent per share, during the quarter.

The Pharmacy Services segment posted a robust 32.3% increase in revenues to $18.3 billion during the reported quarter. The company benefited from the acquisition of the Medicare Part D business of Universal American Corp. last year, new client additions and drug cost inflation.

All these factors also led to a 25.9% year-over-year rise in CVS’ pharmacy network claims to 198.5 million. The new client starts and the ongoing adoption of Maintenance Choice program also drove the Mail Choice claims processed growth by 16.6% to 20.4 million.

Revenues from CVS’ Retail Pharmacy increased 9.9% to $16.0 billion with same-store sales climbing 8.4%. Pharmacy same-store sales during the quarter rose 9.8% on the heels of benefit obtained from Walgreen’s loss of the Express Scripts contract effective January 2012.

Front-end same-store sales spiked 5.3% with 120 basis points (bps) increase due to the extra day of the leap year. Pharmacy same-store sales witnessed a respective 50 bps and 75 bps upside attributable to one extra day of operation in the quarter and an extra day for 2012 being a leap year.

Additionally, when 90-day scripts are counted as one script, pharmacy same-store prescription volumes rose 7.2%. Converting 90-day scripts into 3 scripts, same-store prescription volumes increased 9.2% year over year. Pharmacy same-store sales witnessed a 305 bps drop due to weak flu season, partially offset by the early arrival of the allergy season.

The generic dispensing rate in the quarter increased 270 bps to 76.5% in Pharmacy Services segment and 290 bps to 78.1% in Retail Pharmacy segment.

Cost of revenues during the quarter increased 22.6% year over year to $25.7 million. This contributed to 185 bps contraction in gross margin to 16.6%. Operating margin declined 50 bps to 4.6%.

CVS exited the first quarter with cash and cash equivalents of $2.2 billion, compared to $1.42 billion at the end of fiscal 2011. The company generated $2.4 billion in free cash in the quarter.

During the first quarter, CVS opened 32 new retail drugstores, closed 7 retail drugstore and 1 onsite pharmacy. Additionally, the company relocated 40 retail drugstores. At the end of the quarter, CVS operated 7,428 locations, including 7,352 retail drugstores, 29 onsite pharmacies, 31 retail specialty pharmacy stores, 12 specialty mail order pharmacies and 4 mail order pharmacies in 44 states, the District of Columbia and Puerto Rico.


Based on a solid quarter, CVS raised its EPS outlook for fiscal 2012. The company now expects adjusted EPS of $3.23−$3.33 (earlier guidance being $3.18−$3.28). The current Zacks Consensus Estimate of $3.27 is within this range. CVS anticipates a benefit of roughly 3 cents to 4 cents per share in the second quarter of 2012 from the Walgreen and Express Scripts contract non-renewal.

The company now expects the Retail Pharmacy’s operating profit to increase by 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 at $4.6–$4.9 billion and $6.2–$6.4 billion, respectively.

Our Recommendation

We are encouraged by the improved performance of CVS’ Pharmacy Services segment mainly on the back of significant new client wins due to Walgreen retail contract loss. We strongly believe that the company is well positioned to serve Express Scripts members with access to pharmacy care and customer service.

We are also pleased with the company’s increased guidance for 2012. Although concerns linger given the margin pressure felt by the company, we are confident about CVS’ longer-term potential, based on its retail execution, deployment potential and the strong 2012 generics cycle.

Moreover, we believe the healthcare reform will open up new opportunities for the company. However, the recent merger between Express Script and Medco is expected to intensify competition in the Pharmacy Services segment.

CVS currently retains a short-term Zacks #2 Rank (Buy). Over the long term, we have a Neutral recommendation in the stock.

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