CVS Caremark: A Tale Of Two Businesses

1/19/2010


  Recent Price
$34
  Dividend
$0.35
  Yield

1.0%

  P/E Ratio
13
  Shares (millions)
1,445
  Long-Term Debt as % of Capital
20%
  52-Week Price Range
$38.27 - $23.74

Shares of CVS Caremark ($34; CVS) sprinted to a 23% gain in the first 10 months of 2009, well ahead of the S&P 500 Index’s 17% advance. But in early November the stock pulled up lame, falling 20% on the day CVS announced it had lost $4.8 billion in 2010 contracts. The stock has since regained much, though not all, of the lost ground.

CVS’ pharmacy-benefit-management business (PBM) will not recapture all of that lost revenue at once, but early indications suggest it is moving in the right direction. In December, the PBM unit (48% of sales in the nine months ended September) signed a two-year, $998 million contract with the Teacher Retirement System of Texas. CVS also received a one-year contract extension from Blue Cross and Blue Shield, which accounts for about $4 billion in sales every year. CVS Caremark is a Focus List Buy and a Long-Term Buy.

PBM in rehab

CVS purchased Caremark Rx in 2007, and the strategy of merging a retail pharmacy with a PBM sparked doubts — both anticompetitive and strategic — from the start. The lost contracts have revived some of these concerns. New PBM president Per Lofberg has navigated these waters before. He served as chairman of Merck-Medco Managed Care LLC, a union of dissimilar companies that also triggered antitrust scrutiny. Drugmaker Merck ($38; MRK) eventually spun off the PBM into
Medco Health Solutions ($65; MHS).

Lofberg’s top task is to prevent more clients from leaving. His strategy involves rebuilding the PBM’s marketing program and differentiating its offerings. Before the most recent contract signing, CVS said the segment would post 10% to 12% lower operating profits, down from the 2% to 5% growth expected before the contract losses.

Retail still steady

CVS owes much of its growth in recent years to acquisitions on the retail side, spending billions of dollars to snap up regional drugstores. With the PBM unit on the mend, CVS will rely heavily on its retail pharmacy business (52% of sales). CVS expects retail operations to grow operating profits 13% to 16% in 2010.

Same-store sales rose 5% in the nine months ended September, accelerating in the September quarter. CVS added a net 59 stores in the September quarter, growing the store count above 7,000.

Conclusion

Wall Street expects 8% higher per-share earnings in 2009 and, despite weakness at the PBM, an additional 6% growth in 2010. Stock buybacks have reduced the share count by 5% over the last two years. CVS has launched a new $2 billion repurchase program, and in January it raised the quarterly dividend 15% to $0.0875 per share.

CVS shares trade at just 13 times trailing earnings, a 24% discount to the three-year average. For comparison, the other big PBMs Medco and Express Scripts ($89; ESRX) trade at more than 24 times earnings, a premium to their historical averages. CVS shares also trade at a substantial discount to drugstore chain Walgreen’s ($37; WAG) trailing P/E of 17. An annual report for CVS Caremark Corp. is available at One CVS Drive, Woonsocket, RI 02895; (401) 770-4050; www.cvscaremark.com.

CVS CAREMARK
Quarter

    Per-Share
     Earnings*

Sales
Change

      Quarterly
      Price Range

P/E Ratio
Range

Sep '09 $0.65 vs. $0.60 + 18% $37.75 -

$30.58

15 - 12
Jun '09 0.65 vs. 0.60 + 18% 34.22 - 27.08 14 - 11
Mar '09 0.55 vs. 0.55 + 10% 30.47 - 23.74 12 - 10
Dec '08 0.70 vs.

0.55

+ 10% 34.49 - 23.19 15 - 10
           
Year
(Dec.)

Sales
 (Bil.)

Per-Share
Earnings*
Per-Share
Dividend

52-Week Price Range

P/E Ratio
Range

2008 $87.47 $2.44 $0.26 $44.29
-
$23.19 18 - 10
2007 $76.33 $1.92 $0.23 42.60
-
30.45 22 - 16
2006 $43.81 $1.57 $0.16 36.14
-
26.06 23 - 17
2005 $37.01 $1.38 $0.15 31.60
-
22.02 23 - 16
             
————————————————— Quadrix Scores † —————————————————
Overall Momen-
tum
Value Quality Financial
Strength
Earnings
Estimates
Performance
89 82 91 87 62 25 24

   * Earnings exclude special items.
   † Quadrix® scores are percentile ranks, with 100 the best.


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