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Mixed 2Q for CVS, Raises Outlook

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CVS Caremark (CVS - Free Report) reported second quarter 2012 EPS of 75 cents, up 25% year over year. However, after excluding the impact of certain acquisition related expenses from both the periods, the adjusted EPS in the reported quarter came in at 81 cents, ahead of the Zacks Consensus Estimate by 2 cents and 14.0% higher than the year-ago quarter.  

The increase in the company’s earnings was primarily due to an 18.5% increase in operating profit in its Retail Pharmacy segment that gained considerably from the Walgreen and Express Scripts (ESRX - Free Report) contract termination. The increasing number of generic drugs combined with the momentum in the Maintenance Choice program also helped the company’s bottom line.

Net revenue during the quarter increased 16.3% year over year to $30.7 billion, missing the Zacks Consensus Estimate of $31.0 billion. The Pharmacy Services segment posted a robust 28.2% increase in revenues to $18.4 billion during the reported quarter. The company benefited from new activities associated with the acquisition of the Medicare Part D business of Universal American Corp. last year, new client additions during the fiscal 2012 selling season and drug cost inflation.

All these factors also led to a 13.7% year-over-year increase in CVS’ pharmacy network claims to 197.8 million. The new client starts and the ongoing adoption of the Maintenance Choice program also drove the Mail Choice claims processed growth by 15.5% to 20.5 million.

Revenues from CVS’ Retail Pharmacy increased 6.9% to $15.8 billion with same-store sales climbing 5.6%. Pharmacy same-store sales during the quarter rose 7.2% on the heels of benefit obtained from Walgreen’s loss of the Express Scripts contract in January 2012. Front-end same-store sales increased 2.3% year over year.

Additionally, when 90-day scripts were counted as one script, pharmacy same-store prescription volumes rose 7.7%. Converting 90-day scripts into 3 scripts, same-store prescription volumes increased 9.8% year over year. Pharmacy same-store sales witnessed a 500 basis point (bps) decline attributable to recent generic introductions.

The generic dispensing rate (the proportion of all generic prescriptions to total number of prescriptions dispensed) in the quarter increased 390 bps to 78.0% in the Pharmacy Services segment and 350 bps to 79.1% in the Retail Pharmacy segment.

Gross margin during the quarter contracted 150 bps to 17.7%. Operating expenses were up 3.9% on a year-over-year basis to $3.7 billion. However, operating margin remained flat year over year at 5.6%.

CVS exited the second quarter with cash and cash equivalents of $1.82 billion, compared to $1.41 billion at the end of fiscal 2011. Year-to-date net cash provided by operating activities were $4.0 billion compared to $3.1 billion for the same period last year.

During the second quarter, CVS opened 36 new retail drugstores, closed 8 retail drugstores and 1 onsite pharmacy. Additionally, the company relocated 24 retail drugstores. At the end of the quarter, CVS operated 7,457 locations, including 7,381 retail drugstores, 28 onsite pharmacies, 31 retail specialty pharmacy stores, 12 specialty mail order pharmacies and 5 mail order pharmacies in 44 states, as well as the District of Columbia and Puerto Rico.


Anticipating a benefit of 5 cents per share related to the prescription business to be retained from the contract loss of Walgreen and Express Scripts, CVS raised its EPS outlook for fiscal 2012. The company now expects adjusted EPS of $3.32−$3.38 (earlier guidance being $3.23−$3.33). The current Zacks Consensus Estimate of $3.29 remains below the guidance range.

The company now expects the Retail Pharmacy’s operating profit to increase by 14%–15% (previous guidance being 10.5%–12.5%) while that of the Pharmacy Services to increase by 13%–15% (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. The fiscal 2012 guidance is based on the assumption that the company’s remaining $1.0 billion share repurchase authorization will be completed by the end of fiscal 2012.

Our Take

We are encouraged by the improved performance of CVS’ Pharmacy Services segment, mainly on account 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.

However, earlier in July, the long-standing contractual dispute between Walgreen and Express Scripts came to an end with both the companies announcing a multi-year retail pharmacy network agreement. Although CVS is still optimistic about retaining at least 50% of the business gained from the dispute through the fourth quarter 2012, we prefer to remain on the sidelines until visibility improves in this regard.

This was not the end of the woes for CVS. The mega-merger between Express Scripts and Medco Health Solutions in April this year further intensified the competitive landscape in the PBM industry and put CVS in a tight spot. Moreover, concerns linger given the margin pressure felt by the company.

CVS currently retains a short-term Zacks #3 Rank (Hold). Over the long term (3-6 months), we have a Neutral recommendation on the stock.

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