CVS Health caps off milestone year with solid financial performance

WOONSOCKET, R.I. — CVS Health delivered a solid fourth quarter and strong financial performance in 2014 and, according to CVS Health executives, further demonstrated that its unique business model is winning in the marketplace, capping off a milestone year that will go down in history as the year it exited the tobacco category and rebranded the company.



“It was a great year for our company by any measure,” Larry Merlo, president and CEO of CVS Health, told analysts during Tuesday’s fourth-quarter conference call.



As anticipated, industry observers have been closely watching the impact of CVS Health’s decision last year to pull the plug on all tobacco sales. And, to date, the results have proven positive as the company's PBM business model gives it a lever to help offset lost tobacco sales.



Despite the tobacco headwind, the impact on front-end sales was less than company executives anticipated and resulted in “no discernible” impact on its pharmacy business. Furthermore, former tobacco sales appear to have migrated largely to convenience stores and gas stations.



“The negative impact to our front-store sales has been slightly less than anticipated. We know that the most heavily-impacted categories were consistent with our expectations, but the magnitude of that impact on those categories has been [less] than expected,” Merlo told analysts. “Beyond the categories that we expected to see impacted, other front store categories have not been negatively affected.”



Revenues in the retail pharmacy segment increased 2.9% to $17.7 billion for the fourth quarter ended Dec. 31. Same-store sales increased 1.6% and pharmacy same-store sales rose 5.5%. Front-end same-store sales — which would have been 800 basis points higher if tobacco and the associated baskets were excluded — decreased 7.2%.



“The impact from the exit of tobacco and associated basket sales was about 800 basis points in the quarter, which was 100 basis points less than management’s expectations. The company highlighted that softer customer traffic was partly offset by an increase in basket size,” stated William Blair analyst Mark Miller in a research note.



Furthermore, front-store margins benefited in the quarter from the tobacco exit, improving “modestly.”



“This underlying improvement in front-store margin reflects our discipline in making responsible investments in promotion, along with the continued growth of store brand sales,” Merlo said. “In fact, we made great progress in store brand penetration in the quarter with store brands increasing to 22% of front-store sales. That’s up about 310 basis points from Q4 of last year and about 190 basis of that improvement reflects the removal of tobacco from our mix.”

Miller noted in his research report that, "Retail gross margins increased 70 basis points year-to-year to 31.4%, slightly ahead of our 31.3% forecast and retail segment margins expanded 40 basis points to 10.1%.

The stronger gross margin result is particularly impressive given competitors Walgreens and Rite Aid are both experiencing year-to-year gross margin declines as a result of generic cost inflation. Front-end margins also increased, even including the impact from tobacco, with the improvement attributed to disciplined investments in promotion."



Merlo added that, since the company launched its new CVS Health brand, customer awareness and response to the new branded campaign has been “very positive.”



For the year, total revenue in the retail pharmacy segment increased 3.3% to $67.8 billion. Same-store sales increased 2.1% and pharmacy same-store sales increased 4.8%. Front-end same-store sales were down 4% and would have been about 350 basis points higher if tobacco and the associated basket sales were excluded.



Merlo also touched upon the 2015 selling season. Gross client wins currently stand at $7 billion, with net new business at $3.6 billion — up roughly $400 million from the company’s update provided in December.



“Like the past several years, our success in the 2015 selling season reflects our high levels of service and execution, competitive pricing, along with our unique, integrated model,” said Merlo. “And our model allows us to provide differentiated products and services that generate savings for our clients while providing better health outcomes and convenience for their members.”



With $7 billion in new business, encompassing about 150 new clients serving millions of new members, Merlo said that 2015 proved to be the largest and most complex welcome season its history.



Revenues in the pharmacy services segment increased 21.7% to $23.9 billion during the quarter. The increase was driven by growth in specialty pharmacy, including the acquisition of Coram and the impact of CVS Health’s Specialty Connect program, as well as increased volume in pharmacy network claims.



For the year, total revenue in the pharmacy services segment increased 16.1% to $88.4 billion.



CVS Health’s net income for the quarter increased 4.5% to $1.3 billion. Adjusted earnings per share totaled $1.21. For the year, net income increased 1.2% to $4.6 billion. Adjusted earnings per share totaled $4.22.

Net revenues for the quarter increased 12.9% to a record $37.1 billion. For the year, total revenue increased 9.9% to $139.4 billion.



"We maintain our 2015 EPS estimate of $5.20 and are introducing a 2016 EPS estimate of $5.85. We reiterate our 'outperform' rating for CVS Health, based on the continuation of strong operating momentum and our belief that the integrated model is favorably positioned in the marketplace," Miller stated.