John W. Ransom
Earlier this week [in mid-August], we hosted meetings with management of CVS Caremark (CVS). We highlight the following key takeaways:
Reform is likely to drive retail prescription (or Rx) volume; mail-order growth could be challenged: As the implementation of the Affordable Care Act drives increased health-care utilization among the newly-insured population, prescription drug volumes are expected to rise accordingly.
Since government programs (Medicare, Medicaid) do not permit mandatory mail order requirements, management expects the vast majority of the initial incremental dispensing volume will flow through retail pharmacy channels. Notably, current mail order penetration rates among existing Medicaid and Medicare Part D subscribers remains very low, estimated to be less than 5%.
Taking a conservative approach to international expansion, first “test” market in Brazil: Regarding international growth opportunities, management maintains a cautious approach toward expansion opportunities, targeting only markets that meet specific criteria.
For example, markets must support chain drug stores, must have similar characteristics to the U.S. market in terms of brand/generic dispensing and margin profiles, and must not have been consolidated or dominated by a single player.
After careful evaluation, CVS entered Brazil as a “test” market, with 45 stores currently in operation and a goal to grow the footprint to approximately 1,000 locations; management targets a No. 1 or No. 2 market position vs. the current market leader’s 9-10% share (about 900 stores). Following this disciplined approach, management believes the company could sell/exit the market fairly easily if the investment does not develop as planned.
In terms of future expansion, China remains an attractive market, though current government regulatory issues present a challenge; assuming the market evolves toward more retail Rx distribution (vs. current hospital-based fulfillment), CVS could pursue a joint venture with a local company. Interestingly, management indicated that the U.K. was never viewed as a particularly attractive opportunity; likewise, Canada has become overly concentrated (following the recent Loblaw transaction) with an unfavorable growth profile.
Zacks Investment Research
Based on a strong selling season, CVS is perfectly on track to continue positive growth performance for its pharmacy benefits management (or PBM) franchise through 2013. Apart from that, CVS is also focusing on the 2014 selling season.
Gross new wins for 2014 amounts to $4.4 billion while net new business wins are expected to be $1.7 billion. We are impressed to note that the recent client wins include major Fortune 100 companies, as well as regional health plans in both the commercial and Medicare or Medicaid segments.
CVS also recorded strong claims growth on the back of new client wins and higher membership. Further, in February 2013, CVS extended its Pharmacy Advisor program to cover five additional chronic conditions, namely asthma, depression, osteoporosis, breast cancer and chronic obstructive pulmonary disease. Prior to the extension, the company’s Pharmacy Advisor was directed at diabetes and cardiovascular conditions.
CVS expects to enroll over 900 clients representing 16 million lives in 2013. Moreover, management is progressing well to attain annual savings run rate of $225million to $275 million in 2014 from its PBM streamlining initiative. Specialty pharmacy represents another high-growth avenue.
The soaring demand for specialty pharmacy, especially in the ongoing decade, is likely to accelerate growth for the company. Specialty revenue rose roughly 19% in the second quarter. In fact, CVS expects to cross the $20 billion sales mark on the back of specialty revenue.
Moving forward, management expects drug price inflation, new product launch, higher utilization and new PBM clients to fuel growth. We expect the segment to serve as a stable growth platform going forward.
Christopher R. Growe
Stifel, Nicolaus & Company
Kraft Foods Group (KRFT) reported its 3Q13 EPS of $0.65 (-17%) which was in line with our estimate and $0.04 below the consensus estimate. This quarter’s earnings includes $50 million in one-time costs burdening the earnings (-$0.05 in EPS terms), a $43 million drag on profits from less commodity hedging gain here in 3Q13 (-$0.05 in EPS terms), and a lower than expected tax rate (+$0.03 in EPS terms).
The company reiterated its base business guidance for 2013 EPS of $2.78 (excluding the large pension mark-to-market benefit, but including the 33 cents of one-time charges), $1.2 billion in free cash flow (in line with its guidance last quarter, but up 20% from its initial guidance for 2013), and revenue growth to be in line with or slightly below the growth of the North American food/beverage market. So, while this quarter was below our expectations on a sales and operating-profit basis, the fourth-quarter trends are expected to pick up nicely while benefiting from easier comparisons as well.
The company’s guidance for the year implies EPS guidance for 4Q13 of $0.60 for the quarter predicated on underlying growth well ahead of the North American food/beverage market and up significantly against the easy comparison in the prior year. Restructuring charges trailed our estimate in the third quarter, which should provide a larger drag on fourth quarter earnings as our full year estimate of $325 million in restructuring costs remains in place.
We continue with our Buy rating and $60 target price. This quarter was burdened by a difficult volume comparison, a high level of restructuring charges, and modest revenue growth after adjusting for the unique factors affecting the quarter.
We continue to believe the productivity program will be a significant contributor to earnings and margins for the foreseeable future, particularly during a period of light cost inflation, and the improving rate of revenue growth, should support the 8%-type underlying EPS growth we currently estimate for 2014 and beyond.
Our EPS growth estimate should benefit in 2014 from a normalization of its restructuring costs, but also solid underlying growth for the business. We believe Kraft will continue to showcase a consistency to its growth over the next several years that investors will begin to appreciate. In addition, the nearly 4% dividend yield provides solid downside support for the shares even in a rising interest rate environment, in our opinion.
Ghansham Panjabi, Ph.D.
RPM International Inc. (RPM) is a specialty coatings player with exposure to the high-end commercial roofing, flooring and sealant markets While we remain Neutral-rated on the shares ($40 price target), RPM’s new product execution and share gains in consumer and quick turnaround in industrial are encouraging, though sustainability remains uncertain, in our view. Our $40 price target is based on 11.5 times fiscal year ‘14 estimated [ratio of] enterprise value to earnings before interest, tax, depreciation and amortization.