CVS Caremark Corporation (CVS)

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See all Bulls Reasons Bulls: Reasons To Buy Good at increasing Same Store Sales in acquired stores 100% agree Good at increasing Same Store Sales in acquired stores Remodels of newly acquired Eckerd, Osco, and Sav-on stores will drive revenue and operating margins. View or Edit Reason 1 votes 100% agree Purchasing power means higher margins on meds 100% agree Purchasing power means higher margins on meds Unrivaled economies of scale and purchasing power of the combined company will drive lower prescription prices and higher operating margins. View or Edit Reason 1 votes 100% agree Medicare part D 100% agree Medicare part D Favorable government policy such as Medicare Part D will drive increased prescription sales. View or Edit Reason 1 votes 100% agree See all Bears Reasons Bears: Reasons To Sell Walgreen Company (WAG) remains a more efficient operator than CVS 0% agree Walgreen Company (WAG) remains a more efficient operator than CVS Walgreen Company (WAG) remains a more efficient operator than CVS. View or Edit Reason 1 votes 0% agree The recent merger with Caremark could destroy shareholder value 0% agree The recent merger with Caremark could destroy shareholder value The recent merger with Caremark could destroy shareholder value. View or Edit Reason 1 votes 0% agree Send the authors a comment or suggestion Be the first to make a suggestion See All Suggestions

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CVS and other pharmacies are poised to benefit from an increase in prescription drug demand for several reasons, including the aging baby boomer population and Medicare legislation that prefers generic drugs, which are more profitable for drugstores. ^[4] Increased foot traffic into physical retail locations means increased sales of "front store" items such as cosmetics, photo processing and foods, which comprise nearly one-third of CVS's overall revenue. In addition, CVS in particular has been active in expanding its pharmacare services beyond retail sales to take advantage of an increase in mail-order prescription fulfillment as well as retail health clinics. ^[5]

The road ahead for CVS Caremark is not completely clear, however. The company faces major legal troubles, including prescription errors and quality problems, illegally dumping confidential patient information, breaches of patient confidentiality and perhaps most publicly damaging to the company's image, the accusation of bribing US Senator John Celona (D-RI), who was convicted and plead guilty to mail fraud. The company's extensive legal troubles may negatively affect the overall distracted leadership, customers' brand perception and operations of the business.

[edit] Company Overview

CVS Caremark Corporation operates the popular retail CVS Pharmacy stores, which number over 6,300 nationwide. They also operate the Pharmacy Benefit Manager (PBM) Pharmacare and new acquisitions: the PBM Caremark, retail health clinic MinuteClinic (mostly located inside CVS/Pharmacy stores), and Longs Drug Stores. ^[6]

[edit] Pharmacy

CVS/pharmacy (along with website CVS.com) sells prescription and over-the-counter drugs. Pharmacy sales accounted for 67.8%% of retail sales in 2007. ^[7]

[edit] Front Store

The bulk of CVS/Pharmacy's physical store footprint is the front store (or the "front end") that offers merchandise such of cosmetics, photo processing services, greeting cards, convenience foods, seasonal merchandise, as well as other various retail products. CVS carries a wide variety of private, proprietary, and national brands. In addition to CVS Brand, CVS holds exclusive contracts to sell certain proprietary brands, and the company was the first to sell single-use digital cameras. CVS brand and propriety brand prodcuts accounted for approximately 14% of front store sales in 2007. Front store sales accounted for 19% of revenues in 2007. ^[8]

[edit] Pharmacare

CVS also provides Pharmacy Benefit Management, mail order, disease management, and specialty services through Pharmacare Management Services. ^[9]

Pharmacare recently acquired a very large account: DaimlerChrysler's Chrysler Group. CVS gave Chrysler a very good deal because they were able to leverage the PBM to get more people to come to their retail locations. See Discussion in Trends and Forces

[edit] Health Savings Pass

CVS began in November, 2008 a generic discount program Healthh Savings Pass to rival competitors' success with similar programs. For a $10 membership fee, consumers are able to buy 90-day supplies of many common generic drugs for $9.99, as well as a 10% discount at CVS MinuteClinics. ^[10]

[edit] Business Financials

CVS reported a profit up 7% to $736 million for the third quarter (ending September 27th, 2008), an increase from $689.5 million in Q3 2007. Overall revenues grew 2% to $20.863 billion from $20.495 billion the year before. This growth came from a 5.3% increase in retail drug stores and a 3.7% increase in CVS/pharmacy division same store sales. The pharmacy also opened a net of 39 stores to reach a total of 6,347 currently operating. ^[11]

[edit] Trends and Forces

[edit] Key Acquisitions

[edit] Longs Drug Stores (LDG)

In November 2008, CVS completed the acquisition of Longs Drug Stores (LDG) for $2.7 billion. Longs Drug Stores (LDG) ran a similar business to CVS and was heavily concentrated in California, Hawaii, Nevada and Arizona, markets with few or no CVS store locations. The transaction brought 521 Longs drug stores under CVS ownership, dramatically increasing its presence in these markets. Profits results are expected to decrease for the remainder of 2008 and 2009 partially due to transition costs. ^[12]

[edit] Caremark RX

Caremark RX is a leading pharmacy benefit management (PBM) company that provides comprehensive disease and prescription benefit management services aimed at convenience, cost reduction, and increased effectiveness. They operate a retail pharmacy network that includes over 60,000 participating pharmacies(including CVS/Pharmacy), 28 mail service pharmacies, and an FDA approved repackaging plant (the only one in the industry).

In March of 2007, CVS and Caremark completed the merger, outbidding Express Scripts, another PBM to create one of the first true mergers between a retailer and a PBM. ^[13]

• CVS expects to achieve at least $500 million in cost savings through the merger (e.g., through economies of scale) ^[14]

• This acquisition positions CVS to benefit from the increased trend toward mail order prescription drugs, which has grown from 10% in 1990 to 20% in 2006. Through Caremark and Pharmacare, CVS can profit from this trend as well (or at least maintain current accounts that shift away from retail).

• Centralized Prescription Filling: 60% of drug prescriptions filled at retail locations are from recurring prescriptions. ^[15] CVS Caremark can now push customers these customers to get their scripts in the mail instead, which is less costly and more efficient.

• It is likely that Caremark will convince many of its clients to name CVS as a preferred provider, or it will be able to do so itself. Being a preferred provider will allow a PBM to provide discounted products or services to its members through an agreement with insurers or third-party organizations. Most people whose insurance companies have preferred provider networks use those networks almost exclusively, driving more business to CVS/Pharmacies.

• Consolidation of patient data and reminders: The CVS pharmacist will eventually have access to a patient's entire medication regimen, thus allowing the company to build deeper customer relationships through the PBM as well as local pharmacists.

[edit] MinuteClinic

In 2006, CVS acquired and expanded MinuteClinic, the first and largest retail health clinic in the US. It now operates as a subsidiary of CVS Caremark, with the majority of its 462 clinics housed within CVS/Pharmacy locations. ^[16] MinuteClinic employs board certified nurse practitioners and physician's assistants trained to diagnose and treat/make prescriptions for common illnesses; common vaccinations are also provided.

The MinuteClinic acquisition has benefited CVS Caremark's bottom line in the following ways:

• MinuteClinic is less costly than a typical doctor visit, which makes it more attractive to insurers and cash payers alike
• CVS is leveraging MinuteClinic to drive new business to the pharmacy - 25% of MinuteClinic patients are new CVS customers
• If Caremark or Pharmacare is already an insurer's PBM, sending patients to MinuteClinic will be cheaper for the insurer, and more profitable for CVS.
• CVS plans to put MinuteClinics in about 2,500 CVS/Pharmacy stores

[edit] Eckerd, Osco, Sav-on

In the past 3 years, CVS has grown tremendously by acquiring roughly 2,000 new drugstores from its competition. The new stores have allowed CVS to gain market share in new geographical locations.

In 2004, CVS acquired 1,268 Eckerd drugstores and PBM Eckerd Health Services from J.C. Penny. Through the Eckerd stores, CVS expanded into the Florida and Texas markets. ^[17]

In 2006, CVS continued to grow by acquiring Sav-On and Osco drugstores from Albertsons. The deal included over 700 stores throughout the Chicago area and Southern California. CVS plans to remodel and modernize the stores, which are comparatively less efficient with floorspace, have antiquated merchandising systems, and are generally not kept in attractive condition. These activities could raise their operating margins by an additional 3% above their currently respectable 4%. CVS also acquired 28 Albertsons' Health'n'Home Durable Medical Equipment (DME) stores through the acquisition. The DME stores represent CVS's first steps into the DME market. ^[18]

[edit] What Is Lifting All Boats?

Several external trends are currently increasing all pharmacies' revenues across the industry. In addition to increased sales of prescriptions, CVS will benefit as additional foot traffic for the pharmacy naturally leads to increased retail sales in the front end of the store.

• Baby boomers are only getting older, and will be more likely to need prescription medications in the coming years
• There has been an increase for prescription drug coverage in the last 10 years
• The new Democratic federal government will be more likely to enact legislation to increase spending on health care
• Medicare Part D came into effect in January 2006, which expanded coverage to millions of people who were previously uninsured. Medicare Part D makes it more difficult to prescribe more expensive drugs, shifting overall product mix toward generics (which although cheaper, generate higher margins). Now, over 22 million people are enrolled in Medicare Part D. ^[19]
• Over the next five years, around $50 billion in branded drug sales will lose patent protection, opening them to generics and driving profit margins

[edit] Legal Troubles

Both CVS and Caremark have gotten themselves into sticky situations in recent years. CVS has recently been accused of prescription errors and quality problems, illegally dumping confidential patient information, breaches of patient confidentiality and most recently and the bribery of former Rhode Island state senator John Celona (D-RI), who was convicted and plead guilty to mail fraud. ^[20] Two CVS executives were put on leave of absence for allegedly bribing the Senator to advance CVS's agenda in Rhode Island and in Washington, D.C but were cleared of charges. ^[21]

Caremark has also received a lot of bad press because of other legal issues. The company has been accused of reusing returned mail-order medications, passing off generics and non-preferred brands as preferred brands, serious racial harassment, options backdating and in 1995, Caremark paid the third highest ever criminal settlement of $161 million for paying kickbacks to doctors. ^[22]

The SEC currently has more stringent financial reporting requirements and other regulations for companies that do a significant amount of business with the government, and with increased government spending on Health Care, it's likely to occur eventually for CVS Caremark. Further investigations could generate more bad press, convictions, and high settlements - any of which could decrease consumer and/or investor confidence.

[edit] Economic Slowdown

CVS's revenue comes from both pharmacy sales and non-pharmacy, or front store, sales. Though medical costs such as prescriptions are not discretionary expenses and thus less vulnerable to an economic downturn, patients still migrate towards lower cost generic drugs instead of more expensive brand name drugs. CVS actually stands to benefit from this, as they receive higher levels of reimbursement from groups like Medicare for generic drugs. ^[23] Additionally, CVS CVS Chief Executive Tom Ryan says that very little of front store sales comes from "true discretionary sales," so same store sales are expected to continue to grow. Still, CVS lowered their expected profit by 6 to 7 cents per share for FY2009, citing worries about decreased overall spending from consumers. ^[24]

[edit] Competition

CVS's biggest competitor is the Walgreen Company (WAG), which generated $53.7 billion in 2007 sales. ^[26] Walgreens also has its own PBM--Walgreens Health Services--making it the most comparable to CVS Caremark in terms of breadth of offerings. Walgreens had led CVS in terms of sales and operating margin in recent years until 2007 when CVS's merger with Caremark helped the company surpass Walgreens. CVS earned a 6.2% operating margin in 2007, compared to Walgreen's 5.9% figure. ^{[27] [28]} The result has been greater gains in market share in both prescription drugs and front store sales by CVS than by Walgreens.

CVS also competes for market share with discount stores, particularly Wal-Mart. The retail discount giant has smaller presence in the prescription drug market but dwarfs CVS in front store sales. Its large gains in market share for both prescription drugs and front store sales are likely reflective of customers decreasing spending in face of the economic downturn.

CVS Caremark's other competitors include:

• Rite Aid: $17.5 billion. Rite Aid recently acquired Brooks/Eckerd on the East coast, but both companies are currently struggling. CVS owns several key markets in this region and may be poised to benefit from Rite Aid's decline.
• MedcoHealth: $43.1 billion
• Express Scripts: $17.8 billion
• Other discount stores, food/drug combo stores, mail service prescription services, Internet drugstores, PBMs, and other various sellers of retail and prescription merchandise. Supermarkets currently account for about 12% of the retail prescription market, but they are currently losing market share due to increasing cost pressure industry-wide. It is expected that they may even exit the market in the next couple years. If this trend continues as it is expected to do, CVS and others will be in a position to absorb the market share.

Note 2: A fully transparent breakdown of operating margins is conspicuously absent from all retailers' annual reports, though they provide same store sales, revenue, and sometimes gross margins information.

[edit] References

1. ↑ CVS Caremark 10-K 2007. Section 1 - Business. pg 3
2. ↑ MSN Money. "CVS says tender offer for Longs is complete." 29 October 2008.
3. ↑ CVS Caremark 10-K 2007. Section 2 - Financial Statements and Supplementary Data. pg 32
4. ↑ Drug Channels. "The Attack on Generic Profits in Drug Channels." 21 November 2001.
5. ↑ CVS Caremark 10-K 2007. Section 1 - Business. pg 4
6. ↑ CVS Caremark 10-K 2007. Section 1 - Business. pg 3
7. ↑ CVS Caremark 10-K 2007. Section 1 - Business. pg 4
8. ↑ CVS Caremark 10-K 2007. Section 1 - Business. pg 4
9. ↑ CVS Caremark 10-K 2007. Section 1 - Business. pg 6
10. ↑ Business Week. "CVS will start Health Savings Pass discount plan." 30 October 2008.
11. ↑ CVS FY2008 Q3 10-Q
12. ↑ Associated Press. "Pharmacy sales boost CVS 3Q profit 7 percent." 30 October, 2008
13. ↑ CVS Caremark 10-K 2007. Section 1 - Business. pg 3
14. ↑ CVS Press Release on Caremark Merger.
15. ↑ CVS Caremark 10-K 2007. Section 1 - Business. pg 5
16. ↑ CVS Caremark 10-K 2007. Section 1 - Business. pg 4
17. ↑ CVS Press Release on Eckerd Acquistion.
18. ↑ Chain Drug Review. "CVS' purchase of Osco, Sav-on seen as strategic coup." 11 September 2006.
19. ↑ HHS Monthly Summary on Medicare Part D Enrollment. November 2008.
20. ↑ (D) State Senator John Celona resigns and pleads guilty. 21 June 2006.
21. ↑ Former CVS execs cleared in U.S. bribery trial. 30 May 2008.
22. ↑ US Department of Justice Press Release. 16 June 1995.
23. ↑ Drug Channels. "The Attack on Generic Profits in Drug Channels." 21 November 2001.
24. ↑ Forbes. "Pharmacy sales boost CVS 3Q profit 7 percent." 30 October 2008.
25. ↑ Market Wire. "BIGresearch Retail Ratings: CVS Closes Prescription Drug Gap With Walgreens." October 2008.
26. ↑ Walgreen Company (WAG)
27. ↑ CVS Caremark 10-K 2007. Section 2 - Financial Statements and Supplementary Data. pg 32
28. ↑ Walgreen Company (WAG)