Can CVS Health Recover From The Shocks Of 2016 & 17?

The year 2017 has failed to turn things around for CVS Health (NYSE:CVS) . This leading provider of integrated services across the entire spectrum of pharmacy care has underperformed the S&P 500 market year to date. The stock has lost 5.4% as against the S&P 500 market’s 20.4% gain.

During the first-quarter 2017 earnings call, CVS Health’s President and Chief Executive Officer Larry Merlo said, “We continue to expect 2017 to be a rebuilding year, but our goals remain clear, and we fully intend to return to healthy levels of growth.” Unfortunately, little of this could materialize. The company is still grappling with issues from the past along with other challenges.

2016 Deals Major Blows

CVS Health is still trying to recover from the setback caused by Prime Therapeutics’ collaboration with Walgreens Boots Alliance, Inc. (NASDAQ:WBA) in August 2016. Owing to this, CVS Health lost access to Prime’s 22 million members. Notably, Prime Therapeutics is the fourth largest Pharmacy Benefit Manager (PBM) in the United States owned by 14 leading Blue Cross and Blue Shield health plans.

Another major blow was dealt at the end of 2016 when the TRICARE retail pharmacy network managed by Express Scripts (NASDAQ:ESRX) restricted CVS pharmacies, including those in Target stores, from participating. This network, with more than 57,000 locations, included Walgreens Boots as a member instead.

Thanks to these developments, CVS Health’s shares lost 15.2% in the last five months of 2016.

2017 Hasn’t Been Kind as Well

CVS Health’s Retail/Long Term Care (LTC) business has been sluggish since first-quarter 2017 largely due to declining same-store sales, continued reimbursement pressure and a rise in the generic dispensing rate (the proportion of all generic prescriptions to total number of prescriptions dispensed).

The company’s Retail/LTC business was also majorly impacted by weak operations in hurricane-ravaged areas like Texas, Louisiana, Florida and Puerto Rico. The company has valued the hurricane impact at about $55 million — primarily costs to cover insurance deductibles.

The speculated entry of Amazon.com, Inc. (NASDAQ:AMZN) in the PBM market has aggravated matters for CVS Health. To counter competition, CVS Health will have to add more digital and customer-friendly programs.

CVS Health ~ A Force to Reckon With

“If there is no struggle, there is no progress”

Nothing could be more apt than this remark by Frederick Douglass. CVS Health, with a massive market cap of $74.52 billion, has been leaving no stones unturned to bounce back.

Mergers & Acquisitions to Strengthen PBM Business

In a historic decision, CVS Health decided to acquire the United States’ third-largest health insurance company Aetna (NYSE:AET) in a cash-and-stock deal worth around $207 per share or almost $69 billion (considering a rough estimate of Aetna's debt, the total transaction value is projected at $77 billion). The company expects the takeover to close in the second half of 2018, subject to approval by the company’s shareholders, regulatory bodies as well as fulfillment of certain other customary closing conditions. CVS Health expects $750 million of near-term synergies from the deal, with low to mid-single digit accretion in the second year post closure of the transaction.

Many view the merger as a vertical integration instead of a horizontal one which will lead to efficiency gains and solid cost cutting at CVS Health’s PBM business.

Apart from the Aetna deal, CVS health has announced plans to set up a new 30,000-store performance-based pharmacy network as well as up to 10,000 community-based independently owned pharmacies across the United States. Through this initiative, the company intends to promote cost saving and enhance clinical outcomes which will eventually reduce costs for CVS Health’s PBM customers.

Initiatives to Boost Retail/LTC Business

The company has also been striving to return to growth in the Retail/LTC business. Management claims that CVS Health is focused on working with all payers to drive volumes and capture market share in 2018 and beyond. The company’s tie-up with OptumRx, part of the UnitedHealth Group (NYSE:UNH) , to provide a 90-day Pharmacy solution to OptumRx commercial clients was made available at the beginning of July. CVS Health is also poised to gain from programs such as Health Tag and ExtraCare Health Card. Subsequently, the company is planning to collaborate with PBMs and health plans to offer a menu of services such as MinuteClinic services, Infusion and Long Term Care. Also, Store Brands is an area of both strength and opportunity for CVS Health. The company’s latest initiatives like next-day and same-day delivery and automatic refills of prescriptions with a text message also seem promising.

Recognizing the growing opportunities in the digital market, CVS Health has also been focused on enhancing its online and mobile capabilities in 2017. Building on the strength of its digital tools within pharmacy, with 60% of patients using them, the company is focused on offering advanced services to customers. These services range from Curbside program to same-day delivery options as well as enhanced mobile functionality and ExtraCare. Moreover, CVS Health has been enthusiastically working with Instacart and is now delivering from 2,800 stores.

Is There a Rebound in the Cards?

CVS Health has been firing on all cylinders of late. The company recently inked a five-year agreement with Anthem, Inc. (NYSE:ANTM) to provide services including claims processing and prescription fulfillment to support IngenioRx, a new PBM. Notably, the agreement will be implemented on Jan 1, 2020, and will run through Dec 31, 2024.

While such measures will help smoothen the bumpy ride for the company, 2018 might come with a fresh set of surprises and challenges. (Looking for the Best Stocks for 2018? Be among the first to see our Top Ten Stocks for 2018 portfolio here.)

Broadly speaking, the effects of the massive corporate tax cut from 35% to 21% as proposed under the U.S. tax reform bill are yet to be implemented. Per some analysts, the bill will result in a substantial decline in the effective tax rate for companies in 2018.

Also, this Zacks Rank #3 (Hold) company’s favorable Value Style Score of A raises our confidence in the stock. Our Value Style Score highlights all valuation metrics and represents them as one score that cautions investors regarding “value traps” and helps them find stocks that are actually trading at a discount.

The company also has a favorable price to earnings ratio of 12.5 as compared to the S&P 500 market’s 21.3 and broader industry’s 13.2.

Bottom Line

In a market, where mergers and acquisitions have been historically altering the landscape along with challenges like legal regulations and reimbursement pressure, it will be interesting to see how CVS Health deals with the odds and delivers the promised long-term earnings growth of 10%.

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