(CVS) CVS Caremark Corporation Shares Remain at Neutral

We have reiterated our Neutral recommendation on CVS Caremark Corporation (CVS) with a target price of $47.00.

CVS Caremark’s second quarter adjusted earnings per share (EPS) increased 14.0% year over year to 81cents, beating the Zacks Consensus Estimate by 2 cents. Net revenues increased 16.3% to $30.7 billion, nominally missing the consensus estimate.

CVS has now seen six consecutive quarters of strong performances for Pharmacy Services. In spite of some contract losses in the current selling season, net new business wins for 2013 stood at an encouraging level of $640 million to date. The latest wins include major Fortune 100 companies as well as regional health plans in both the commercial and Medicare or Medicaid segments. Moreover, CVS has taken steps to make prescription drugs more affordable to consumers through programs such as Maintenance Choice and Pharmacy Advisor.

CVS’ retail segment continues to perform strongly, contributing 46% of the company’s overall revenues in the second quarter of fiscal 2012. The strength, which is evident from the higher same-store sales during the last-reported quarter, benefited from market share gains following the termination of the contract between Express Scripts Holding Company (ESRX) and Walgreen Co. (WAG). The stalemate between these two big players diverted many customers from Express Scripts to CVS, which led to a 7.2% growth in CVS’ pharmacy same-store sales.

Also, we are impressed to note that, even with Walgreen re-entering the Express Scripts network this September 15, CVS remains optimistic about retaining at least 50% of the prescription volumes gained from their earlier feud. Anticipating this, the company expects a benefit of 5 cents per share to its bottom line.

The company now expects the Retail Pharmacy segment’s operating profit to increase by 14%–15% (previous guidance being 10.5%–12.5%) while that of the Pharmacy Services to increase by 13%–15% (11%–15%).

The company is also confident about achieving margin expansion in 2012. One of the primary reasons for this assumption is the huge potential of generic drugs. In the reported quarter, CVS’ PBM generic dispensing rate grew 390 bps to 78.0%.

However, despite implementing diverse strategies to expand its business, CVS may face major difficulties with the recent announcement of a multi-year retail pharmacy network agreement between Walgreen and Express Script. We prefer to remain on the sidelines until visibility improves in this regard.

Moreover, the recent merger between Express Script and Medco has posed more challenges for CVS in the Pharmacy Services segment. The deal combined two of the three largest U.S. drug benefit managers and created a dominant player in the Pharmacy Benefit Management (PBM) space to cover more than 150 million prescription drug consumers and 50% of the large employer market. Consequently, we remain apprehensive based on the huge and growing market leading capacity of the merged entity compared to CVS. CVS carries a Zacks #3 Rank (short-term Hold rating).

Read the full analyst report on “CVS”
Read the full analyst report on “ESRX”
Read the full analyst report on “WAG”
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