CVS reported 4Q17 revenue growth of 5.3%, and adjusted EPS of $1.92 (+12% y/y) at the high end of its guidance. CVS provided its 2018 guidance which was good, although expected profit was lowered by 250bps to account for the $275M reinvestments that will be made in the business (wages/benefits, data analytics and new store format). We are not surprised by this disclosure as it was our assumptions that extra cash from the tax reform would be put into the business. We remain bullish on the company’s strategy and are maintaining our position size and price target.
Current Price: $71.23 Price Target: $90
Position Size: 2.39% Performance LTM: -7.5%
Thesis Intact. Key takeaways from the quarter:
1. Consolidated revenue was up 5.3%, and consolidated operating margins were flat y/y
a. Retail sales were up 0.3% and overall SSS +0.1%: front store SSS -0.7% and pharmacy SSS +0.4% (even with a 340bps negative impact from lower price generics, while volume was up 2.5%). Operating margins were down 10bps y/y
b. PBM sales +9.3%. Growth driven by increase in pharmacy network and specialty drugs, brand inflation and SilverScript (Medicare Part D), which now serves 13.3M lives, an 8% increase from last year. Operating margins were up 15bps y/y
c. A quarter of the front store sales are from their private label brand, leading to improved gross margins
2. Detailed 2018 guidance provided
a. Net revenue growth of 0.75% to 2.5%
i. Retail/LTC growth of 2.5% to 4%, SSS of 2-3.5%
ii. Pharma services growth of 1.5-3.5%
b. Adjusted operating profit growth of (1.5%) to 1.5% due to reinvestments into the business
i. Retail/LTC profit down low-single digits
ii. Pharma services profits growth low to mid-single digits
c. PBM selling season seeing good growth, with net new business of $2.4B, and retention rate of 96.5%, which should help pharmacy results
d. Share repurchase on hold due to Aetna deal, dividend maintained
e. Reduction in tax rate will yield $1.2B cash benefits. CVS provided additional clarity on how the cash will be used, disclosing that at least $275M of the $1.2B will be reinvested as follow:
i. Spending a least half on debt reduction to return to a leverage ratio in the mid 3X within 2 years
ii. Investing in the business:
1. Increase in wages and benefits (minimum wage going to $11/hr, and offering maternity leave benefit)
2. Invest in data analytics
3. Invest in stores to pilot new offerings (for example broadening the MinuteClinics services such as blood draw and chronic disease management)
3. Valuation: we are maintaining our price target of $90
a. Currently trading at x11 forward P/E
b. FCF yield of ~8.2% is very attractive
Thesis on CVS
• Market leader: largest pharmacy benefit manager (PBM) in the US. This gives CVS scale advantage and negotiating power with pharma companies to obtain better drug pricing discounts. Also the largest US pharmacy retailer, giving it more touch points with consumers/patients. Finally, market share leader in long-term care pharmacy sector thanks to its Omnicare acquisition.
• Stable and predictable top line and margin profile. CVS benefits from an ageing population in increasing needs of prescription drugs.
• shareholder friendly, offering a 7% shareholder yield (5% share repurchase + 2.6% dividend yield)