Steven P. Halper
Before the market open on November 3, CVS Caremark reported solid 3Q’11 results. During 3Q’11, retail same-store sales were 2.3 percent, and the company appears to be tracking nicely to its full year guidance of 1.5-2.5 percent. Notably, front-store comparable sales increased 2.0 percent, which is the strongest performance in two years.
The company did not sacrifice margin to drive same-store sales. However, the company expects increased promotional activities in 4Q’11. We are not concerned about this given the strong retail performance over the first nine months of the year. Pharmacy benefit management (PBM) performance continues to improve and the company reiterated its view that it expects “healthy” growth in PBM profitability in 2012.
The company will provide more specifics regarding its 2012 outlook at its investor day in late December, which is likely to be the next near-term catalyst for the stock. Our 2011 and 2012 adjusted EPS estimates remain unchanged at $2.80 and $3.23, respectively, but both estimates are already above consensus.
The company raised the low end of its 2011 EPS guidance range to reflect the quarter as well the accretion related to the divestiture of its TheraCom unit. We have increased our target price from $42 to $44, mainly to reflect the change from year-end 2011 to year-end 2012. Given the likelihood of strong free cash flow over the next five years and beyond, we remain buyers of the shares.
As reported, consolidated revenue in the quarter increased 12.5 percent year over year. Retail-segment revenue (before eliminations) grew 3.8 percent and PBM revenue grew 26 percent. Retail growth was driven primarily by 2.3 percent in comparable-store sales. Front store sales grew 2.0 percent while pharmacy comparable sales increased 2.4 percent. Generics negatively impacted sales growth by 200 basis points while maintenance choice increased sales by 140 basis points.
Looking ahead, the company expects 4Q’11 same stores growth of 0.5-2.5 percent (we are forecasting 2 percent) and lower gross profit margin due primarily to increased promotional activities. Operating profit should still grow 4-7 percent in 4Q’11. We are not concerned about the decline in gross margins in 4Q’11 given the strong year-to-date performance.
Looking ahead to 2012, we assume same-store sales of 3.6 percent and just 6.0 percent growth in operating profit. Our operating profit growth assumption is probably conservative.
PBM network revenue grew 24 percent year over year, driven primarily by the Aetna contract. Mail choice revenue grew 16 percent (another sequential increase).
Eric Serotta, CFA
Wells Fargo Securities
We are reiterating our Outperform rating on shares of Kraft Foods following solid Q3’11 results characterized by strong organic top-line growth and effective cost management. We continue to believe the planned split-up of the company will unlock value for shareholders given the above-peer growth profile of the global snacks company, the operational improvement opportunities available to each company, and the ability of each company to pursue different capital allocation priorities.
Kraft reported Q3’11 adjusted EPS of $0.58, $0.03 above consensus and in line with our estimate. While adjusted EPS benefited by approximately $0.04 from a favorable tax rate, operating results were nevertheless strong. Sales increased 8.4 percent on an organic basis, driven by 7.0 percent pricing and 1.4 percent volume/mix benefit.
Kraft Foods reported its 3Q’11 EPS was up 23 percent to $0.58, which was $0.04 ahead of our estimate and $0.03 ahead of the consensus estimate, although the majority of this earnings “beat” flows from a lower tax rate in the quarter.
This quarter’s performance was another solid one, in our view: Organic revenue growth of +8.4 percent and organic operating profit growth of +12 percent led to the strong EPS growth conclusion in the quarter.
EPS was about in line with our expectation excluding the tax benefit, but with such strong revenue growth, including volumes. We see this quarter as one that should lift the stock price from this level and provide high confidence in the upcoming fourth quarter. In addition, the company raised its 2011 revenue growth guidance again (to at least +6 percent growth) and its EPS growth guidance (to at least $2.27, up $0.02).