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Sluggish Segments Sour CVS Earnings Beat

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CVS Caremark (CVS - Free Report) reported first-quarter 2013 earnings per share (EPS) of 77 cents, up 29.9% year over year. However, excluding one-time expenses, the adjusted EPS rose 28.1% to 83 cents, beating the Zacks Consensus Estimate of 79 cents.

This reflects the fifth consecutive quarterly earnings beat for CVS. Moreover, the quarterly result beat the company’s expectation of 77 to 80 cents.

Quarter Under Review
Net revenue decreased 0.1% year over year to $30.8 billion in the quarter, surpassing the Zacks Consensus Estimate of $30.3 billion. 
The Pharmacy Services segment revenues clambered 0.1% to $18.3 billion in the quarter. The segment gained from drug cost inflation and volume growth across all channels. However, the generic wave in the pharmaceutical industry adversely impacted the segment revenues. 
The higher claims related to Medicare Part D program, a relatively strong flu season and client wins also led to 4.3% year over year growth in CVS’ pharmacy network claims to 207.1 million. The new client gains and ongoing adoption of the Maintenance Choice program increased the Mail Choice claims processed to 20.5 million, up 0.6% on a year-over-year basis.
Revenues from CVS’ Retail Pharmacy improved 0.2% year over year to $16.1 billion. Same-store sales decreased 1.2% while front-end same store sales grew 1.4% year over year. Despite the positive impact of a burdensome flu season and Easter holiday in the quarter, same-store sales declined in the reported quarter. 
Pharmacy same store sales declined 2.3% from the year-ago quarter due to generic introductions and absence of leap year in the last quarter which dragged sales by 925 basis points (bps) and 70 bps, respectively. On the other hand, favorable calendar shifts (Easter holiday in Mar 2013) had a positive impact of 65 bps on front-end same store sales in the quarter.
Also, high incidence of flu had a positive impact of 90 bps in the quarter. However, absence of leap year had an adverse impact of 120 bps on front-end same store sales. 
Moreover, counting 90-day scripts as one script, pharmacy same-store prescription volumes improved 2% from the year-ago quarter. When 90-day scripts were converted into 3 scripts, same-store prescription volumes increased 4.7% from the prior-year quarter. 
The generic dispensing rate (the proportion of all generic prescriptions to total number of prescriptions dispensed) soared 400 bps to 80.5% in the Pharmacy Services segment and 300 bps to 81.2% in the Retail Pharmacy segment.
Gross margin expanded 150 bps to 18.1% on the back of higher profitability across both segments due to generic introductions. Operating expenses were up 4.7% on a year-over-year basis to roughly $3.9 billion in the quarter. However, operating margin increased 90 bps to 5.5%.
CVS exited the quarter with cash and cash equivalents of $1.55 billion compared with $1.38 at the end of 2012. Net cash provided by operating activities declined 41.1% to $1.6 billion. This resulted in free cash flow of almost $1.32 billion in 2012, down 45.1% from the prior year. 
During the first quarter, CVS opened 37 new retail drugstores, closed 9 retail drugstores and relocated 15 retail drugstores. As of Mar 31, 2013, CVS operated 7,596 locations, which include 7,531 retail drugstores, 18 onsite pharmacies, 31 retail specialty pharmacy stores, 12 specialty mail order pharmacies and 4 mail order pharmacies in 45 states, as well as the District of Columbia and Puerto Rico. 
Following the first quarter, CVS narrowed its guidance for 2013 adjusted EPS to the range of $3.89 – $4.00 compared with $3.86 − $4.00 earlier. The current Zacks Consensus Estimate of $3.95 lies within the guidance range. The revision is on account of the impact of the sequestration on the company’s Medicare Part D business. 
On the other hand, CVS reiterated its expectations for 2013 free cash flow and cash flow from operations in the range of $4.8 – $5.1 billion and $6.4 – $6.6 billion, respectively. The guidance includes the completion of the accelerated share repurchase agreement of $4 billion.
For the second quarter of 2013, CVS expects adjusted EPS in the band of 94 cents and 97 cents. The current Zacks Consensus Estimate of 94 cents tallies with the lower end of the company’s outlook.
Our View
CVS reported another positive quarter to surpass the Zacks Consensus Estimate. The strong selling season and higher profitability are material upsides for the company. However, CVS witnessed a slowdown in segment growth. The decline in pharmacy services revenues after several quarters of robust growth is a cause of concern. 
Currently, CVS carries a Zacks Rank #2 (Buy). Other Zacks Rank #2 healthcare stocks that warrant a look are BioScrip Inc. (BIOS - Free Report) , Rite Aid Corporation (RAD - Free Report) and Accuray Inc. (ARAY - Free Report) .

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