CVS Faces Steepening Challenges in Its Pharmacy Benefit Management Business

Senior Equity Analyst

Julie Utterback

Revenue segments as reported by the company.

Products

Premiums

Services

Net investment income

Revenue Segments

Gross Profit, Operating Income, and Net Income as a percentage of Revenue

Gross Margin

Operating Margin

Profit Margin

Margins

An operating expense is an expense a business incurs through its normal business operations. Often abbreviated as OPEX.

Benefit costs

Operating expenses

Goodwill impairment

Store impairments

Opioid litigation charges

Loss on assets held for sale

Restructuring charge

Operating Expenses

Year over year growth in Revenue and Operating Expenses.

Revenue Y/Y

OpEx Y/Y

Growth

Shares outstanding refer to a company's stock currently held by all its shareholders, including share blocks held by institutional investors and restricted shares owned by the company's officers and insiders.

Outstanding Shares

Market Cap

Also known as Price/Sales Ratio. Calculated using Average market cap for the quarter / Annualized quarterly revenue.

Revenue Multiple

CVS aims to be the most customer-centric health company in the United States and has spent over a decade positioning itself as a managed care leader, with the acquisitions of pharmacy benefit manager Caremark (2007), insurance provider Aetna (2018), and healthcare service provider Oak Street (2023) defining its strategic direction. CVS' top-tier retail pharmacy, health insurer, and PBM franchises create the potential to improve health outcomes and even bend the healthcare cost curve for its clients, especially if it can align incentives by owning healthcare service providers, as well.

CVS appears uniquely positioned to improve health outcomes, and we appreciate management's focus on better leveraging its assets through digital and other means to bring a more consumer-centric approach to healthcare, which could provide many benefits. For example, management recently highlighted an observational study that showed when members use both CVS medical and pharmacy benefits, their medical costs decline 3%-6% over a three-year period through factors like fewer hospitalizations and emergency room visits. Driving savings like that would be attractive to many potential clients, like self-funded employers, and CVS' own at-risk operations, like its Medicare Advantage plans, by reducing medical costs. Also, CVS continues to dive further into healthcare services through its HealthHub strategy and recent acquisitions of primary-care assets. We think the relatively high-margin healthcare services business could eventually accelerate CVS' profit growth directly or by reducing long-term costs in its medical and pharmacy benefit businesses. 

With its integrated strategy, management aims to accelerate bottom-line growth to the low double digits on a maintainable basis in the long run, but management has pushed the target date for that back multiple times. Now, we only think that growth rate is possible with significant share repurchases toward the end middle of our explicit 10-year forecast period on mid-single-digit operating profit growth in the long run.

Business Strategy & Outlook

CVS Health earns a narrow economic moat rating from us. As a top-tier medical insurer, pharmacy benefit manager, and pharmacy retailer, we believe CVS possesses enough scale-related cost advantages to generate economic profits for the long run. Even after the late 2018 Aetna merger, which cut into returns on invested capital including goodwill, and its recent healthcare services acquisitions, we estimate that CVS' ROICs should remain above its capital costs throughout our explicit 10-year forecast period. CVS generates profits almost equally among its three major segments, and we see the medical insurance and PBM assets as generally stronger than the retail store chain. 

In medical insurance, we see two moat sources—cost advantage and network effects. An insurer’s cost advantages relate primarily to scale, both broadly and locally. The legacy Aetna operations represent the third-largest insurer that we cover, with about 26 million members, albeit a distant third in our coverage universe behind Elevance and UnitedHealth. With such significant scale in the fragmented health insurance market, we believe CVS benefits from local scale advantages in specific metropolitan markets. Local scale advantages allow for greater negotiating leverage versus service providers than smaller insurers in each community, which contributes to cost advantages in each specific location. Also, when local scale advantages are significant enough, we think CVS’ insurance operations benefit from a network effect. According to the American Medical Association, the share of local insurance markets in the U.S. that were highly concentrated grew to 75% in 2021 from 71% in 2014, with the leaders likely taking share in those markets due to local market dynamics. For example, in communities where CVS already has substantial market share, it can offer lower costs or more benefits per member to existing and potential clients than its peers. If that offering is compelling enough, more employers will be attracted to CVS’ insurance plans in those communities, and local service providers, such as hospitals and physician groups, will have more incentive to join and offer lower prices to CVS’ insurance networks to gain access to its large, growing membership rolls. As CVS’ local market share rises, its negotiating leverage with providers also rises, which can create a virtuous cycle (a network effect) where CVS attracts even more clients and more providers to its insurance network in that area. Overall, these dynamics create barriers to entry for would-be competitors, as compiling an attractively priced provider network in a new geography would be difficult without an established membership pool.

CVS’ Caremark segment provides PBM services and appears competitively advantaged in its own right with a combination of moat sources. The PBM industry has consolidated into three top players—CVS, UnitedHealth, and Cigna—controlling nearly 80% of U.S. prescription volumes on an adjusted basis, and we believe those players built their leadership on previous cost advantages. However, with limited cost advantages over each other, we see evidence of some switching costs (through contracts) and network effects now, although CVS' recent contract losses create some new uncertainty around these moat sources, in our opinion. We believe CVS’ leadership position in its PBM operations should help it generate excess returns over time. We continue to view the fixed-cost leverage associated with processing about 2 billion of the nearly 7 billion adjusted prescriptions filled annually. This consolidation of purchasing power helps CVS extract discounts from drug manufacturers on one end of the transaction and pharmacies on the other end of the transaction, which helps create value for its clients, such as insurance plans and employers, on their pharmacy cost trends. We see some switching costs in this business with contract lengths typically around three years and annual retention rates in the high 90s for all three of the top-tier PBM players. Switching the administrative activities, partner relationships, and pharmacy benefit plan specifications to a new PBM vendor can be time-consuming and onerous, which creates inertia for clients with limited realistic alternatives, in our opinion. However, switching is possible, and the loss of specific clients could constrain the firm's growth eventually, especially as new insurance competitors like Elevance, Amazon, and the Mark Cuban Cost Plus Drug Company taking aim at this market. 

CVS possesses a top-tier position in retail pharmacy stores that appears to have some positive qualities, if not a strong moat. CVS drives significant volumes through over 9,000 pharmacy locations. This large store network is attractive for pharmacy benefit managers when assembling plans to obtain volume-based discounts from pharmaceutical manufacturers, and also assembling convenient retail store locations that would be attractive to an insurance plan members. And while it trails Walgreens’ average revenue per store, CVS’ average store revenue remains significantly higher than most other U.S. pharmacies. Scale allows CVS to leverage fixed costs (such as pharmacist salaries and rent) more effectively than subscale peers, and both CVS and Walgreens continue to steal share from smaller independent pharmacies. CVS, Walgreens, and Walmart also have advantageous relationships with the top U.S. drug distributors, which may give them a mild leg up over other retail pharmacies on generic drug pricing. Beyond that, these retail store locations give CVS a unique asset that it may be able to leverage into destinations for higher-margin healthcare services, like primary care, eventually.

In terms of environmental, social, and governance issues, our narrow-moat view of CVS is informed by an analysis of potential changes to the U.S. healthcare system. The key long-term ESG risk that CVS faces, in our opinion, is how U.S. strives to reach universal, affordable coverage. While some strategies considered in recent years to reach universal coverage included eliminating the private insurance industry, those plans have largely been rejected for more moderate proposals that build on the existing healthcare system and include private insurers even in government-sponsored programs like Medicare and Medicaid. During the next 10 years, we view scenarios where CVS provides medical and pharmaceutical benefits through employers and government-sponsored programs (like Medicare Advantage and Medicaid MCOs) as much more likely than not. And overall, since the 2020 election, the impact of potential policy changes has been limited, and we suspect considered changes in the near term (such as increased regulations on the PBM) will be manageable for CVS.

Narrow

Economic Moat

CVS Health

Aetna is an American managed health care company, which sells traditional and consumer directed health care insurance plans and related services, such as medical, pharmaceutical, dental, behavioral health, long-term care, and disability plans. Aetna is a member of the Fortune 500.

Aetna

CVS Pharmacy is a subsidiary of the American retail and health care company CVS Health, headquartered in Woonsocket, Rhode Island. It was also known as, and originally named the Consumer Value Store and was founded in Lowell, Massachusetts, in 1963. The chain was owned by its original holding company Melville Corporation since its inception until its current parent company CVS Health was spun off into its own company in 1996. CVS Pharmacy is currently the largest pharmacy chain in the United States by number of locations (over 9,600 as of 2016) and total prescription revenue. As the retail pharmacy division of CVS Health, it ranks as the 7th largest U.S. corporation according to Fortune 500 in 2016. CVS Pharmacy's leading competitor Walgreens Boots Alliance ranked 37th.

CVS Pharmacy

CVS Health Corp. is a health solutions company, which engages in the provision of healthcare services. It operates through the following segments: Pharmacy Services, Retail or Long-Term Care, Health Care Benefits, and Corporate and Other. The Pharmacy Services segment focuses on the pharmacy benefit management solutions. The Retail or Long-Term Care segment includes the sale of prescription drugs and an assortment of health and wellness products, and general merchandise. The Health Care Benefits segment offers traditional, voluntary, and consumer-directed health insurance products and related services, including medical, pharmacy, dental and behavioral health plans, medical management capabilities, Medicare Advantage and Medicare Supplement plans, Medicare Part D prescription drug plan, Medicaid health care management services, and health information technology products and services. The Corporate and Other segment is involved in providing management and administrative services. The company was founded by Stanley P. Goldstein and Ralph Hoagland in 1963 and is headquartered in Woonsocket, RI.

Earnings data Q1 2024

Revenue

Cost of revenue

Gross profit

SG&A

Other

Operating income

EBITDA

Net income

Earnings per share

Total assets

Current assets

Cash & equivalents

Receivables

Inventory

Non-current assets

Net PPE

Intangibles

Total liabilities

Current liabilities

Short term debt

Income tax payable

Non-current liabilities

Long-term debt

Total equity

Stockholders equity

Minority interest

Total liabilities & equity

Total debt

Net debt

Book value per share

Cash from operations

Funds from operations

Change in working capital

Cash from investing

Capital expenditure

Purchase/sale of investments

Purchase/sale of business

Other sources

Cash from financing

Change in stock

Change in debt

Cash dividends paid

Cash from other sources

Net change in cash

Free cash flow

WOONSOCKET, R.I. , Nov. 7, 2023 /PRNewswire/ -- CVS Health (NYSE: CVS) will hold its Investor Day on December 5th, 2023, in Boston, MA.

CVS Health to hold Investor Day on December 5, 2023

Perficient

Tenable Holdings Inc

The market has begun to rebound in recent days due to the U.S. Federal Reserve keeping interest rates steady, signaling the rate hike cycle has possibly come to an end. This is a welcome change since the sharp sell-off that began in late July triggered by inflation fears and the potential impact on elevated rates on economic growth and company earnings.

Don't Get Stuck with These 3 Declining Stocks

Chevron

Dollar General

Essential Properties Realty Trust Inc

Realty Income Corp

Public Storage

Vanguard Real Estate ETF

There are a handful of REITs that could fit most portfolios. They offer a combination of high yield, growth, upside, and safety. We highlight two such REITs that we are buying heavily.

2 REITs All Investors Should Own

If any health crisis has been in the news over the last few years, it has been the opioid crisis, and while it's been somewhat pushed aside due to mounting Fentanyl deaths attributed in part to the issues at the border, the toll taken over that period was tremendous.

6 Reasons To Avoid CVS (CVS) Stock Today

CVS Health stock dipped after the company reported third-quarter results on Nov. 1. CVS Health's largest operating segment lost a big client earlier this year.

CVS Health Is Down 27% This Year. Is the Stock a Buy on the Dip?

Pfizer

CVS Health's headwinds could only be temporary. UPS' CEO is optimistic about the company's prospects.

3 Beaten-Down, High-Yield Dividend Stocks That Wall Street Predicts Could Soar More Than 25% Over the Next 12 Months

Walgreens

CVS Health Corp and Walgreens Boots Alliance on Wednesday said that a work action by some U.S. pharmacists this week had minimal impact on operations, with most stores remaining open.

CVS and Walgreens say pharmacist work action had minimal impact

CVS Health delivered better-than-expected revenue and earnings for its third quarter of 2023. The pharmacy chain also lowered its full-year earnings outlook, however, citing elevated utilization trends within its Medicare Advantage business and lower-than-expected script volumes.

Why CVS Health Stock Dropped Today

Robust sales growth across all three operating segments drove CVS Health's (CVS) third-quarter results.

CVS Health (CVS) Q3 Earnings Surpass Estimates, Margins Up

CVS Health (CVS) posted better-than-expected results on gains in its health services business, but shares fell 1% in early trading Wednesday as the big pharmacy chain reduced its unadjusted profit guidance.

CVS's Results Beat Forecasts, but Shares Fall as It Cuts Full-Year Unadjusted EPS

CVS Health Corporation (CVS) Q3 2023 Earnings Call Transcript

Although the revenue and EPS for CVS Health (CVS) give a sense of how its business performed in the quarter ended September 2023, it might be worth considering how some key metrics compare with Wall Street estimates and the year-ago numbers.

CVS Health (CVS) Q3 Earnings: How Key Metrics Compare to Wall Street Estimates

CVS Health Corp (NYSE:CVS) bobbed and weaved to put the best gloss on its third-quarter earnings update early on – only to see the stock flop 4.2% premarket. Okay, the good news was that the bottom-line numbers for the last three months exceeded the Street's expectations.

CVS shares drop 4.2% on guidance downgrade

AbbVie

Analog Devices

Applied Materials

Advanced Micro Devices

AMETEK

ANSYS

Broadcom

Bath and Body Works

ON Semiconductor

Tired of the S&P 500's three-month losing streak? Help might be on the way in November.

November Is The S&P 500's Best Month — 10 Stocks Rally Every Time

CVS Health reported third quarter net income of $2.2 billion thanks in part to contributions from its new healthcare services acquisitions.

CVS Health Profits Eclipse $2.2 Billion As Company Integrates New Provider Businesses

CVS revises lower its guidance range for diluted GAAP earnings per share for the third straight quarter.

CVS Earnings Top Estimates but Stock Drops as Outlook Slashed Again

CVS Health Corp.'s stock CVS was up 0.8% premarket Wednesday, after the drug store chain posted stronger-than-expected third-quarter earnings, shrugging off lower profit guidance for the full year. The company had net income of $2.265 billion, or $1.75 a share, for the quarter, after a loss of $3.399 billion, or $2.59 a share, in the year-earlier period.

CVS Health's stock up after earnings beat, but company lowers full-year EPS guidance

CVS Health Corp beat Wall Street estimates for quarterly profit on Wednesday as strength in its drugstores and pharmacy benefit management business offset higher-than-expected medical costs at its insurance unit.

CVS profit beats estimates on strong performance of pharmacy operations

WOONSOCKET, R.I. , Nov. 1, 2023 /PRNewswire/ -- CVS Health Corporation (NYSE: CVS) today announced operating results for the three months ended September 30, 2023.

CVS Health reports third quarter results

Pharmaceutical concern CVS Health Corp (NYSE:CVS) will enter the earnings confessional before the open tomorrow.

Pharma Giant Prepares for Earnings Call

Rite Aid

Rite Aid Corp

Workers at pharmacy companies CVS (NYSE: CVS ), Walgreens (NASDAQ: WBA ) and RiteAid (OTCMKTS: RADCQ ) have staged a strike that has them walking out on the businesses for three days to highlight working conditions The strikes at CVS, Walgreens and RiteAid are focused on unsafe working conditions. Employees of these companies are focusing on how understaffed locations are, requiring a daunting amount of work for the company's workers.

Strike Alert 2023: Workers at CVS, Walgreens, Rite Aid Walk Out

Investors often turn to recommendations made by Wall Street analysts before making a Buy, Sell, or Hold decision about a stock. While media reports about rating changes by these brokerage-firm employed (or sell-side) analysts often affect a stock's price, do they really matter?

Wall Street Analysts Look Bullish on CVS Health (CVS): Should You Buy?

Aetna CVS Health Individual and Family Plans combine the quality health insurance coverage of Aetna®, with affordable care options at CVS Pharmacy® and MinuteClinic® locations to help members achieve their best health. WOONSOCKET, R.I.

News for CVS Health Stock (CVS)