CVS Caremark Corporation (CVS) reported second-quarter 2014 adjusted earnings per share (EPS) of $1.13, up a significant 16.5% year over year. The result also surpassed the Zacks Consensus Estimate by 3 cents as well as the company-provided guidance range of $1.08 to $1.11 per share. Without the one-time adjustments, reported EPS in the first quarter surged 16.7% to $1.06.
Per management, both the Pharmacy Services and Retail Pharmacy segments were favorably impacted by increase in generic drug dispensed and the State of California's finalization of Medicaid reimbursement rates relative to the company’s historic rate estimates.
Quarter Under Review
Net revenue improved 10.7% year over year to $34.6 billion, beating the Zacks Consensus Estimate of $33.41 billion.
The Pharmacy Services segment revenues increased 16.2% to $21.8 billion in the quarter. The segment gained from increase in net new business, growth in specialty pharmacy business – including the acquisition of Coram – as well as the impact of Specialty Connect, drug cost inflation and product mix, partially offset by an increase in generic dispensing.
Pharmacy network claims that were processed during the quarter edged up 2.2% to 210.4 million. The increase was owing to new client starts. However, decline in Medicare Part D claims partly hampered this growth.
Moreover, decline in traditional mail volumes, which was partially offset by growth in Maintenance Choice program, brought the Mail Choice claims processed to 20.5 million, down 1%.
Revenues from CVS’ Retail Pharmacy improved 4.5% year over year to $16.9 billion. Same-store sales increased 3.3% while front-end same store sales declined 0.4% year over year. Same-store sales improved on account of growth in prescription volumes and brand name drug cost inflation.
Front-end same-store sales decline was attributed to softer customer traffic, partially offset by an increase in basket size. Front store same-store sales in the quarter were positively impacted by approximately 80 basis points (bps) due to a shift in Easter (from March in 2013 to April in 2014). According to the company, excluding tobacco and the estimated associated basket sales, front-store same store sales would have been approximately 110 bps higher.
Pharmacy same-store sales increased 5.0% in the reported quarter. Despite the generic introductions that dragged sales by 160 bps and implementation of Specialty Connect that affected sales by 130 bps, CVS posted pharmacy same-store sales growth. Moreover, Pharmacy same-store prescription volumes rose 3.9% on a 30-day equivalent basis.
The generic dispensing rate (the proportion of all generic prescriptions to total number of prescriptions dispensed) soared 180 bps to 82.4% in the Pharmacy Services segment and 160 bps to reach 83.5% in the Retail Pharmacy segment.
Although gross profit increased 8.3% to $6.3 billion, gross margin contracted 42 bps to 18.3%. Gross margin for the Pharmacy Services business was 5.5%, registering an expansion of 34 bps year over year. The same for the Retail Pharmacy segment was 31.4%, up 39 bps from the year-ago quarter. Operating expenses were up 6.4% on a year-over-year basis to roughly $4.1 billion in the quarter. Operating margin expanded a marginal 6 bps to 6.4%.
CVS exited the quarter with cash and cash equivalents and short-term investments of $1.71 billion, down from $4.18 billion at the end of 2013. Net cash provided by operating activities for the year increased 20.7% to $3.07 billion. This resulted in free cash flow of $2.2 billion for the reported quarter.
During the second quarter, CVS opened 34 new retail drugstores and closed 4 existing ones. Further, the company relocated 8 retail drugstores.
As of Jun 30, 2014, CVS operated 7,859 locations, which include 7,705 retail drugstores, 860 health care clinics, 17 onsite pharmacies, 24 retail specialty pharmacy stores, 11 specialty mail order pharmacies, 4 mail service dispensing pharmacies and 84 branches and 6 centers of excellence for infusion and enteral services in 47 states, as well as the District of Columbia, Puerto Rico and Brazil.
Guidance
Following the end of the second quarter 2014, CVS raised its adjusted EPS guidance for 2014 to the range of $4.43 to $4.51 from the earlier guided band of $4.36 to $4.50. The current Zacks Consensus Estimate of $4.46 falls within the guidance range.
The company reiterated its 2014 free cash flow guidance in the range of $5.5 to $5.8 billion and increased its cash flow from operations guidance to $7.2 billion to $7.5 billion from the earlier range of $7.0 to $7.3 billion.
For the third quarter of 2014, the company expects to report adjusted EPS in the range of $1.11 to $1.14. The current Zacks Consensus Estimate of $1.13 falls close to the upper end of the guidance range.
Our Take
Following an unimpressive first quarter, CVS Caremark is back in form with second quarter beats on both the EPS and revenue front. The Pharmacy Services segment was positively impacted by growth in specialty pharmacy and favorable purchasing economics while the Retail Pharmacy segment was positively impacted by increased sales and an improved margin rate, partially offset by incremental store operating costs associated with operating more stores. As expected, the finalization of Medicaid reimbursement rate reduction had positive impact on the company’s pharmacy margins in the second quarter.
We are upbeat on solid growth in the PBM segment, especially the growth of the specialty pharmacy business. Moreover, having generated strong free cash flow in the quarter, the company is confident of achieving its 2014 goals.
CVS continues to benefit from the introduction of generics that pushed profits higher. It also witnessed robust double-digit growth in PBM on the back of a strong selling season.
Currently, the stock carries a Zacks Rank #3 (Hold). Some of the better-placed stocks in the broader Medical sector are Edwards Lifesciences Corp. (EW), Hologic Inc. (HOLX) and Abaxis, Inc. (ABAX), all carrying a Zacks Rank #2 (Buy).
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