CVS Caremark Misses Earnings on Weather Woes - Analyst Blog

CVS Caremark Corporation CVS reported first-quarter 2014 adjusted earnings per share EPS of $1.02, up a significant 22.9% year over year. However, the result missed the Zacks Consensus Estimate by 3 cents as well as the company-provided guidance range of $1.03 to $1.06 per share. Without the one-time adjustments, reported EPS in the first quarter surged 23.3% to 95 cents.

Per management, the EPS failed to meet the guidance because of severe unforeseen weather-related issues that the company experienced throughout the reported quarter.

Quarter Under Review

Net revenue improved 6.3% year over year to $32.69 billion, closely beating the Zacks Consensus Estimate of $32.54 billion.

The Pharmacy Services segment revenues increased 10.3% to $20.2 billion in the quarter. The segment gained from growth in specialty pharmacy business, including the acquisition of Coram, as well as drug cost inflation, new clients and new products.

Pharmacy network claims that were processed during the quarter edged up 0.4% to 208.9 million. This increase was owing to new client starts. However, decline in traditional mail volumes, which was partially offset by growth in Maintenance Choice program, brought the Mail Choice claims processed to 19.8 million, down 3.6%.

Revenues from CVS' Retail Pharmacy improved 2.7% year over year to $16.5 billion. Same-store sales increased 1.4% while front-end same store sales declined 3.8% year over year. Same-store sales improved on account of growth in prescription volumes and brand name drug cost inflation.

This positive impact was partly tempered by the introduction of generic drugs. Front-end same-store sales decline was attributed to weaker flu season and severe weather in most part of the U.S. Front store same-store sales were also negatively impacted by approximately 80 basis points due to a delayed Easter (from Mar 2013 to Apr 2014) as well as softer customer traffic.

Pharmacy same store sales were up 3.8% from the year-ago quarter. Despite the generic introductions that dragged sales by 120 bps, CVS posted pharmacy same-store sales growth. Moreover, Pharmacy same-store prescription volumes rose 2.1% on a 30-day equivalent basis.

The generic dispensing rate (the proportion of all generic prescriptions to total number of prescriptions dispensed) soared 190 bps to 82.4% in the Pharmacy Services segment and 170 bps to reach 82.9% in the Retail Pharmacy segment.

With a 6.5% increase in gross profit to $5.9 billion, gross margin expanded 4 bps to 18.2%.Gross margin for the Pharmacy Services business was 4.6%, registering an expansion of 40 bps year over year. The same for the Retail Pharmacy segment was 31.4%, up 60 bps from the year-ago quarter. Operating expenses were marginally up 1% on a year-over-year basis to roughly $3.9 billion in the quarter. Operating margin expanded 68 bps to 6.2%.

CVS exited the quarter with cash and cash equivalents and short-term investments of $2.85 billion, down from $4.09 billion at the end of 2012. Net cash provided by operating activities for the year increased 32.4% to $2.17 billion. This resulted in free cash flow of $1.8 billion for the reported quarter.

During the first quarter, CVS opened 22 new retail drugstores and closed 7 retail drugstores,one specialty retail pharmacy and one infusion branch. Further, the company relocated 9 retail drugstores.

As of Mar 31, 2014, CVS operated 7,829 locations, which include 7,675 retail drugstores, 17 onsite pharmacies, 24 retail specialty pharmacy stores, 11 specialty mail order pharmacies, 4 mail service dispensing pharmacies and 84 branches and six 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 first quarter 2014, CVS reconfirmed its adjusted EPS guidance for 2014 in the range of $4.36 to $4.50. The current Zacks Consensus Estimate of $4.47 falls within the guidance range.

The company also reiterated its 2014 free cash flow and cash flow from operations guidance in the ranges of $5.5 to $5.8 billion and $7.0 to $7.3 billion respectively.

For the second quarter of 2014, the company expects to report adjusted EPS in the range of $1.08 to $1.11. The current Zacks Consensus Estimate of $1.09 falls close to the lower end of the guidance range.

Our Take

After several quarters of strong performance, CVS provided an unimpressive first quarter with an earnings miss and a marginal beat to the top line. CVS is facing higher costs associated with its Medicare Part D business that might hamper operating profit in the pharmacy benefit management PBM franchise.

However, we are upbeat with solid growth in the PBM, 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 #2 (Buy). Some of the better-placed stocks in the broader Medical sector are Cardinal Health, Inc. CAH, Hologic Inc. HOLX and The Cooper Companies Inc. COO, all carrying a Zacks Rank #2 (Buy).