Earnings Scorecard: CVS Caremark

Subsequent to the announcement of CVS Caremark’s (CVS) second quarter fiscal 2010 results on July 28, 2010, revision of estimates among analysts depict a downward trend.

Second Quarter Highlights

CVS Caremark reported an EPS of 60 cents for the second quarter of fiscal 2010, unchanged from the year-ago period. However, after considering certain adjustments, the EPS was 65 cents, missing the Zacks Consensus Estimate by 3 cents and unchanged from the year-ago period.

Revenues decreased 3.5% year over year to $24.0 billion, primarily due to a major disappointment in its Pharmacy Services segment. This segment recorded a 9% decline in revenues to $11.8 billion, driven by the termination of some large contracts (effective since January 2010) announced by the company earlier.

In addition, the number of lives covered under Medicare Part D program declined due to the 2010 competitive bidding process, partially offset by new client wins. However, after adjusting for the recent generic introductions, the decline in revenues would have been lower, at 3.1%.

Based on a disappointing quarter, CVS has lowered its outlook for 2010. The company expects retail same-store sales to increase at 2%-3.5%, down from the previous guidance of 3.5%-5.5%. CVS also lowered its adjusted EPS outlook for 2010 to $2.68-$2.73 from $2.77-$2.84.

For a full coverage on the earnings, read: CVS Misses, Cuts Guidance

In accordance with the company’s disappointing guidance, the recent Zacks Consensus Estimate revision trends remain negative.

Over the past 30 days, 15 of 20 analysts covering the stock have made downward revisions for the third quarter without any opposite movement. Besides, estimates for fiscal 2010 and fiscal 2011 were lowered by 16 analysts with only analyst raising the estimates for fiscal 2011. Estimates for the third quarter were lowered by 13 analysts with 2 doing the reverse.

Revenues in the Pharmacy Services segment declined 9% driven by the termination of previously announced loss of some large contracts effective January 2010. In addition, the number of lives covered under Medicare Part D program declined due to the 2010 competitive bidding process, partially offset by new client wins.

Moreover, although the Retail Pharmacy segment recorded an annualized growth of 3.7%, softness in the segment has been witnessed for a number of reasons. These include decline in sales of flu-related products, decline in maintenance scripts due to lower doctor visits arising from economic uncertainty and widespread unemployment. Moreover, a key protein pump inhibitor (PPI), Prevacid, was shifted to OTC status in November 2009, resulting in rapid decline of PPI scripts as payers changed their plans accordingly.

Although CVS has been witnessing problems with its PBM segment, its recent agreement with Aetna (AET) should boost the company’s top line going ahead. CVS has received a 12-year contract from Aetna to provide PBM services to Aetna’s customers. This contract will enable CVS to cater to 9.7 million PBM members of Aetna and administer approximately $9.5 billion in annual drug spending.

However, financial terms of the deal were not disclosed. Although this deal will have a negative impact of 1-2 cents to CVS’ adjusted EPS in 2010 due to implementation expenses, it will be accretive by 1-3 cents in 2011 and exceed 5 cents in 2012. We believe this might have triggered a positive estimate revision for 2011.

Magnitude of Estimate Revisions

The magnitude of estimate revisions for the forthcoming quarters has been significant. In the past 30 days, estimate for the third and fourth quarter has dropped by 4 cents to 65 cents and 3 cents to 81 cents, respectively. Moreover, estimates for fiscal years 2010 and 2011 have reduced by 10 cents to $2.70 and 8 cents to $2.99, respectively, in the past 30 days.

Our Recommendation

During the second quarter of 2010, CVS Caremark recorded a drop in revenues for the first time in recent few quarters due to a weak flu season, economic uncertainty and the disappointing performance of the PBM segment. Near term outlook of CVS seems to be challenging due to issues which have been discussed. As a result, the Zacks #4 Rank (sell) is based on the near term headwinds of the company.

However, we believe the contract with Aetna should boost the company’s top line going ahead. Furthermore, CVS is has strong balance sheet, which enables it to reward shareholders in the form of share buybacks and dividends. Moreover, we believe the healthcare reform will open up a big opportunity for the company.

We remain optimistic about domestic demographic trends, which are expected to drive utilization rates for years to come as the population ages. Thus, retail pharmacy operators like CVS Caremark should be able to grow and capture market share. Additionally, the company’s mail order service is gaining popularity, which will aid in providing additional top line opportunities.

Given the long term potential of the company, we are Neutral on the stock.

CVS CAREMARK CP (CVS): Free Stock Analysis Report

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