Six Reasons Why We Are Bullish On CVS Caremark Stock

Despite all initial skepticism about the viability of integrated retail-PBM business model, CVS Caremark (NYSE:CVS) has not only turned around the outlook of its pharmacy services business within a year by winning multiple high profile contracts and emerging as the second largest player, but has also keenly leveraged its 7,400-strong drugstore network to unlock the full potential of the PBM business through differentiated and unique offerings, that it calls its “integration sweet spots” like Maintenance Choice and Pharmacy Advisor.

Also, its core retail business continues to be as robust as ever and is benefiting from the Walgreen-Express impasse and margin expansion as more prescription drugs go generic this year. Here we look at six reasons why we are more optimistic about CVS Caremark compared to its competitors like Walgreen (NYSE:WAG), Rite Aid (NYSE:RAD) and Express Scripts (NASDAQ:ESRX).

View our detailed analysis for CVS Caremark

1. PBM Turnaround

CVS Caremark aggressively expanded its PBM business in 2011 by winning multiple high profile contracts, including CalPERS, Aetna, FEP and Universal American and quickly turned around the company’s outlook for the business. Last quarter, its PBM revenues grew 32% as it processed 17% more mail choice and 26% more pharmacy network claims compared to the prior year period, benefiting from its leading market share in Medicare Part D prescription business as well as high growth in specialty pharmacy and strong adoption of its Maintenance Choice plans.

2. Leading Presence in Medicare Part D Plans

Over the past one year, CVS has gradually consolidated its PBM market share in the federally-sponsored Medicare Part D prescription business (primarily focusing on Americans aged 65+) through acquisitions like the Medicare PDP business of Universal American and Health Net. In 2012, CVS Caremark’s Part D share has grown by 2.1 million persons enrolled, primarily due to the contracts with Universal American and HealthNet, plus organic growth of 207K enrolled. It now serves over 4 million, just marginally behind UnitedHealth, which lost almost half a million enrolled last year. ((The 2012 Part D Market: The Big Get Bigger, Drug Channels, February 2012))

Medicare Part D is set to get a boost from the aging U.S. population and health reforms that would significantly increase prescription utilization and help plug the Medicare Part D coverage gap, or doughnut hole. The segment is expected to grow in double digits annually over this decade. The U.S. government is rapidly emerging as the major payer for prescription drugs. It is expected that Medicare and Medicaid could be paying for as much as two-thirds of all U.S. prescriptions by 2020, up from about one-third today, indicating a huge opportunity for CVS Caremark.

3. Maintenance Choice 2.0: Revitalized With An Integrated Capability

The company is also benefiting from its integrated offering, Maintenance Choice program, which extends the mail-order benefit for Caremark’s PBM members, enabling them to pick up maintenance medications at any CVS retail pharmacy at the same price as mail-orders with no increase in co-pay or payer pricing.

By the end of 2011, the program had 10 million members enrolled with strong client adoption rates. It has now upgraded to Maintenance Choice 2.0 and expects to add tens of millions more clients in the next two years.

The flexible mail/retail option becomes even more attractive because of CVS’s focus on Medicare Part D business. The mail order utilization is relatively low with Medicare Part D and thus Maintenance Choice would bring significant prescriptions business to its 7,400-strong drugstore network.

4. Pharmacy Advisor 3.0

CVS also seeks significant customer growth through its Pharmacy Advisor program, an offering intermixing its retail and PBM capabilities that connects pharmacists, patients and physicians in real time to identify and timely address patient non-adherence and gaps in care, reducing the overall health care costs. The condition-based program currently focuses on diabetes with 12 million members, including 700K diabetes patients, and is likely to expand to 13 different conditions by 2013, including cardiovascular disease in 2012, followed by asthma, depression, cancer, osteoporosis, GI disorders, rheumatoid arthritis, multiple sclerosis and chronic kidney disease by 2013.

5. Growth in Specialty Segment

CVS has also strengthened its position in the Specialty Pharmacy business, a segment made up of complex medications to treat such serious diseases as cancer by leveraging its integrated retail-pharmacy services business model and MinuteClinics to deliver more value to its customers. Specialty pharmacy is currently a $15 billion business for CVS Caremark, having grown at 17% annually over the past two years.

6. Benefit from Express-Walgreen Fallout

CVS Caremark has significantly benefited from the fallout last quarter gaining millions of new prescriptions as Express members looked for non-Walgreen pharmacies to fill their prescriptions, and ended up at CVS stores as the most convenient alternative. CVS’s retail segment revenues increased 10% last quarter (y/y), driven by 8.4% higher same store sales.

As a result, CVS has raised its full year guidance, and it has now turned more aggressive in a bid to retain these new customers hoping that the more time that Walgreen takes in renegotiating with Express Scripts, the stickier these new customers might become as they continue to frequent CVS drugstores and develop a relationship with its pharmacists. CVS could tap up to 20 million transferred prescriptions out of the Express-Walgreen impasse if it continues through 2012.

We have a $47.40 price estimate for CVS Caremark stock, at 5% premium to the current market price.

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