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07/06/15 10:00:12 AM
FOCUS STOCK OF THE WEEK

CVS HEALTH CORPORATION (CVS)

CVS HEALTH CORPORATION : (CVS)



This week's Focus Stock of the Week is CVS Health Corp. (CVS: $105.55), which carries S&P Capital IQ's highest investment recommendation of 5-STARS, or Strong Buy.



CVS operates one of the largest drug store chains and pharmacy benefit managers in the U.S., based on revenues, net income and store count. Through its retail stores, the company aims to improve customer access to care while helping lower overall health care costs and improve health outcomes. As a result, in addition to filling prescriptions, its retail pharmacists are increasing their focus on providing services, such as flu vaccinations and in-person counseling. Additionally, through its many possible interactions with customers through both retail (stores and websites) and pharmacy services (mail and specialty pharmacy, call centers), the company strives to influence plan members in behaviors that lower costs and improve health care outcomes.



CVS operates more than 7,800 retail drugstores, in 44 states, in the District of Columbia, Puerto Rico and Brazil. The company has stores in 98 of the top 100 U.S. drug store markets, holding the number one or number two market share in 88 of these markets. It filled more than 756 million prescriptions in 2014, accounting for about 21% of the U.S. retail pharmacy market.



CVS's pharmacy services segment provides a full range of pharmacy benefit management (PBM) services including the operation of mail order pharmacies, specialty pharmacies, Medicare Part D services, formulary management and discounted drug purchase agreements. This business generated $88.4 billion of sales in 2014, or 57% of total company sales (excluding intersegment eliminations). The company's specialty pharmacy business operates 27 retail specialty pharmacy stores, 11 specialty mail order pharmacies and four mail service pharmacies.



We expect total company sales in 2015 to rise 7.6%, reflecting $4.5 billion in net new pharmacy benefit management client wins and 2% net square footage growth, partially offset by lost sales from the removal of tobacco products from its shelves in September 2014. We see revenue benefits from new member gains in its SilverScript Medicare Part D prescription drug plans, after CVS was adversely impacted in 2014 after it was sanctioned by the Centers for Medicare & Medicaid Services, excluding it from marketing to new members in Fall 2013.



With the retail drug store market becoming more saturated and with the company seeking to boost purchasing scale, CVS agreed in June 2015 to acquire Target's (TGT 82 ***) pharmacy business, consisting of 1,660 locations and 80 in-store health clinics, for approximately $1.9 billion. The deal is subject to closing conditions and is expected to close by the end of 2015. CVS expects the deal to be $0.06 diluted to EPS in 2016, but $0.10 accretive to EPS in 2017.



Seeking to further expand its offerings into new customer channels, the company agreed to acquire Omnicare (OCR 94 ***), a prescription drug and service provider to the long-term health and specialty health care industries, for a total enterprise value of $12.7 billion in May 2015. The deal is expected to close by the end of 2015, pending regulatory and customary closing conditions. CVS believes the deal will be $0.08 dilutive to EPS in 2015 reflecting financing and one-time transaction costs. However, CVS sees EPS accretion of $0.20 in 2016 and $0.30 in 2017, reflecting significant synergies in revenues, purchasing and improved operating efficiencies.



The company acquired Coram LLC, a specialty infusion services and enteral nutrition business, from Apria Healthcare Group for $2.1 billion in January 2014. CVS projects a $0.03 to $0.05 EPS benefit from the transaction in 2015.



We expect EBITDA margins to be flat in 2015 at 7.7%, reflecting improved generic drug purchasing, increased sales leverage and increased profitability from in-store health clinics, offset by increased drug reimbursement pressures and an unfavorable shift in business mix. We expect benefits from CVS's multi-year technology streamlining initiative to significantly offset investment costs.



Following our estimated 4.2% decline in shares outstanding due to an active share repurchase program, we see 2015 operating EPS of $5.19, up 23% from operating EPS of $4.22 for 2014 (excluding amortization of intangibles in both years).



Our 12-month target price of $121 implies a forward P/E multiple of 20X, at the high end of its 10X-20X trading range from 2007-2014 (post its acquisition of Caremark), applied to our 2016 pro-forma EPS estimate of $6.04, including $0.20 in expected accretion following the completion of its acquisition of Omnicare, and $0.06 in dilution from its acquisition of TGT's pharmacies.



Risks to our recommendation and target price include a greater-than-expected decline in drug reimbursements from federal and state governments, as well as a loss of market share within the PBM services or retail pharmacy businesses.



S&P Capital IQ's views on stocks are constantly re-evaluated. Please refer to our most recent publication on this stock to see our current view.



 

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