CVS Caremark Corporation (CVS): What Can Earnings Tell Us?

Shares of CVS Caremark Corporation (NYSE:CVS) have enjoyed a fantastic run over the past six months. From a price of $44 only six months ago, shares advanced to a roughly $60 price tag today – an impressive 36% rise in such a short time. Not only that, but CVS also vastly outperformed the health care sector as a whole. Take a look at the graph below.

From looking at the graph, you can easily see that the Health Care Sector SPDR, despite its robust run, lost ground to CVS Caremark Corporation (NYSE:CVS). The question now remains whether there’s still a place for an additional increase in prices or perhaps we have reached the top and now is the time to abandon the ship

The catalyst behind CVS

CVS is the No. 1 prescription-medicine provider in the U.S. It employs 280,000 people nationwide and is the largest employer of pharmacists and nurse practitioners. Around 75% of the U.S. population lives within a few miles of a CVS Caremark Corporation (NYSE:CVS) store. That proximity will translate into huge profits as Baby Boomers approach retirement… By 2030, one-fifth of the population will be age 65 or older. Naturally, older people need more prescription drugs than younger folks. And more than 30 million people will gain Medicare coverage by 2014, which means even more prescriptions will be written.

The pharmacy benefits management business (PBM) of Caremark is growing as employers and government look for ways to get cheaper drugs (generics) and manage the prescription and drug costs more efficiently. Customers are looking for the same thing. Patients want convenient access to inexpensive drugs. Unique to CVS Caremark Corporation (NYSE:CVS) is Caremark’s ability to offer 90-day supplies of drugs at mail-order prices. CVS can mail them or provide them for pick up at its stores. It calls this service Maintenance Choice. Competitors Walgreen Company (NYSE:WAG) and Wal-Mart Stores, Inc. (NYSE:WMT) currently cannot provide this convenience. And if the U.S. Postal Service cuts back on Saturday and Friday deliveries (as has been proposed), this feature will become more valuable.

What can earnings tell us?

The company just announced blockbuster earnings on May 1. Net income rose 23% to $956 million. The gross margin in the first quarter widened from 16.6% to 18.1%. And CVS Caremark Corporation (NYSE:CVS) beat revenue estimates by $600 million. Despite the recent rise in the price of shares, they are still trading on the cheap – at price-to-earnings and price-to-sales ratios of 13 and 0.5, respectively. Competitors Walgreen and Wal-Mart Stores, Inc. (NYSE:WMT) are equally cheap and share the same valuation metrics as CVS. Nevertheless, It’s worth noting that Walgreen and Wal-Mart are much more capital efficient than CVS. Whereas CVS management produces 10% on equity, Wal-Mart’s and Walgreen Company (NYSE:WAG) returns on equity are a staggering 22% and a healthy 14%, respectively.

Warning signs

There are, however, significant risks both to the business and to the stock price. I will mention three of them.

  1. Drug pricing: “Too much” deflation in drug pricing will not allow CVS to grow profits at a rapid rate, and could cause them to decline. Its very large (Caremark) pharmacy benefits management business is extraordinarily competitive. Investors may at any time receive an unpleasant surprise out of that division with no warning.

  2. High dependency:
    CVS Caremark Corporation (NYSE:CVS) is much more tied into healthcare, rather than general retail, than its major competitors, especially Wal-Mart Stores, Inc. (NYSE:WMT) and Walgreen Company (NYSE:WAG). This makes it more dependent on reimbursement policies of insurers, whether governmental (i.e. Medicare and Medicaid) and private insurers. With Obamacare coming into effect soon, unknown ramifications may ensue.

  3. Balance sheetCVS has almost no tangible book value – its tangible book is only 2.3% of total assets. That is a direct result of CVS’s buyout spree over the years. The company has issued debt and equity to acquire operating, generally-underperforming pharmacy chains (plus the PBM Caremark). It has eliminated their brand names, taken over their leases and any other assets, and consistently improved their profitability. Because of this strategy and the financial strategy of spending cash to shrink share count, the company has little financial cushion should business turn down.

This Fool thinks health-care

I strongly believe that despite the recent run-up in price and despite a higher risk level, CVS shares are still a buy. CVS’s outstanding management has been able to create the ultimate one-stop-shop for health care customers. With Obamacare kicking in and the expanding profit margins of CVS, I believe it’s in a great position to see big profits down the road.

The article Is CVS Caremark Still a Buy? originally appeared on is written by Shmulik Karpf.

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