Fitch Affirms CVS Caremark at 'BBB+'; Outlook Stable
Fitch Ratings has affirmed its ratings on CVS Caremark Corp. (NYSE: CVS), including the long-term Issuer Default Rating (IDR) at 'BBB+'. The Rating Outlook is Stable. CVS had $10.8 billion in debt outstanding at Sept. 30, 2012. A full rating list is provided at the end of this release.
The affirmations reflect the company's relatively steady credit metrics and strong liquidity position. Fitch expects CVS to manage its credit profile and capital allocation within the context of maintaining its publicly stated adjusted debt/EBITDA (including NPV of lease obligations) ratio of 2.7 times (x). The ratings also consider CVS's strong positioning in all prescription distribution channels, with a #2 market position in the retail segment and pharmacy benefit management (PBM) and a #1 position in the fast-growing specialty pharmacy business, making it the largest provider of prescriptions in the U.S. with a 21% share of 2011 prescription volume.
The company is well positioned to drive continued market share gains and capitalize on favorable industry trends for prescription growth such as the aging population and expansion of coverage to the uninsured, the continued growth in higher-margin generics and mid-teens growth in specialty pharmacy over the next five years. Of concern are the ongoing cyclical pressures on the industry, the industry-wide pressure on pharmacy pricing and reimbursement rates in both the retail and PBM businesses, and any potential hit to profitability from regulatory issues. Ongoing healthcare reform initiatives could pressure reimbursement rates but be positive for prescription volume over the intermediate term if a prescription plan is put in place for the uninsured.
Retail EBIT Growth Expected To Be In The 8%-9% Range Between 2011-2014:
The retail segment which accounts for approximately 70% of operating profit continues to perform well in spite of near-term cyclical pressures and the company continues to lead the drug retail sector in sales productivity and other operating metrics. It has had a successful track record in integrating large-scale retail acquisitions over the past 10 years, while maintaining a healthy level of growth and improving profitability on an organic basis.
As large-scale retail acquisition opportunities are limited going forward, share gains will depend on: generating above-average organic growth; store closings or share losses by weaker independents and regional chains; and small market fill-in acquisitions and prescription file buys. Fitch expects retail top-line growth to be in the 3%-4% range going forward with comparable store sales growth in the 1.5%-2% range (excluding the benefit from gaining scripts from Walgreen this year) and square footage contribution in the 1%-1.5% range. Operating profit growth is expected to be 14% in 2012 and around 6% in 2013-2014, with continued pharmacy pricing and reimbursement pressures offset by a robust generic pipeline, continued improvement at acquired units, and expense leverage on higher volume. Retail EBIT margins are expected to increase by 30-35 basis points (bps) annually over the next two years on an expected base of 8.9% in 2012.
PBM Business Operating Profit Margin Expected To Expand In 2013 After Four Years Of Decline:
CVS has seen positive momentum in its PBM segment since 2011 from a top line perspective with strong business wins that were accretive in 2012, including the ramp up of Aetna and the UAM acquisition which contributed $5.5 billion in incremental revenue in 2012. The company has won $24 billion of net new business over the past three years. Revenues have grown in the mid-20% range in 2011-2012 and are expected to grow in the low single digit range going forward.
The company should finally be able to realize margin expansion in 2013 and beyond in this business segment from a 2012 expected level of 3.6% as the company integrates large scale contracts such as Aetna Inc. The company should also begin to realize benefits from the streamlining initiatives that it put in place in late 2009 to deliver over $1 billion in cost savings from 2011-2015, with benefits outweighing costs in 2012.
Overall EBIT Growth Of 9%-10% expected in 2013; Strong FCF Continues:
Fitch expects total EBIT growth including retail to be in the 9%-10% range for 2013, after growing 14%-15% in 2012. CVS continues to generate strong free cash flow (FCF) providing the company with strong financial flexibility. Fitch expects $3 billion to $3.2 billion in annual FCF (after dividends and before any sales leaseback transactions) over the next few years. Fitch expects excess cash flow after capital expenditures will primarily be used toward increased dividends, share buybacks, and any bolt-on acquisitions within the context of maintaining adjusted debt/EBITDAR at 2.7x. The company's liquidity is also supported by various credit facilities that support its $3.5 billion commercial paper program.
The company has debt maturities of $550 million each in 2014 and 2015 and $700 million in 2016. CVS recently issued $1.25 billion of 2.75% senior notes due 2022 and is currently conducting a tender offer to buy up to $1,325 million of its 2016, 2017 and 2019 debt maturities which total $3.45 billion.
WHAT COULD TRIGGER A RATING ACTION
Positive: Continued strong operating momentum combined with a sustained reduction in lease-adjusted leverage to the low-2x area could lead to a positive rating action.
Negative: Shareholder-friendly actions that push adjusted leverage to 3.0x or above for an extended period could lead to a negative rating action.
Fitch has affirmed CVS's ratings as follows:
--Long-Term Issuer Default Rating (IDR) at 'BBB+';
--Senior unsecured bank facility at 'BBB+';
--Senior unsecured notes at 'BBB+';
--Short-term IDR at 'F2';
--Commercial paper at 'F2'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'. The issuer did not participate in the rating process other than through the medium of its public disclosure. The ratings above were unsolicited and have been provided by Fitch as a service to investors.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Short-Term Ratings Criteria for Non-Financial Corporates' (Aug. 9, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology
Short-Term Ratings Criteria for Non-Financial Corporates
Monica Aggarwal, CFA, +1-212-908-0282
One State Street Plaza
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Phil Zahn, CFA, +1-312-606-2336
Megan Neuburger, +1-212-908-0501
Brian Bertsch, New York, +1-212-908-0549