John W. Ransom
We reiterate our Outperform rating on shares of CVS Health (CVS) following the release of strong Q3’14 results, with trends in both segments continuing to track ahead of our and internal expectations. While the profit cadence is expected to slow in Q4 (tobacco, generics timing), we continue to believe the 2015 outlook provides a view into double-digit EPS growth alongside robust free cash flow (FCF) generation. Additionally, momentum in pharmacy benefits management (PBM ) remains robust, as witnessed by recent selling season success; we view this trend as sustainable given competitive differentiation.
Call highlights: (1) The $26 billion of 2015 PBM contract renewals are 80% complete with a 96% retention rate; (2) management continues to expect the deflationary nature of generics to persist, aside from a select group that continue to experience price increases; and (3) per management, any incremental cash flow over and above guidance will be a pull-forward from 2015, rather than a step-up in operations.
Management narrowed the full-year adjusted earnings-per-share (or EPS) guidance to $4.47-$4.50 (from $4.43-$4.51) and provided Q4’14 guidance of $1.18-$1.21 vs. consensus of $1.21.
Revenue growth guidance was also raised 75 basis points at the midpoint. Further, free-cash-flow guidance was raised to $5.7 billion-$6.0 billion (from $5.5 billion-$5.8 billion), with capital expenditures of $1.7 billion. Yet, share buyback expectations remain at $4 billion.
Our 2014 non-GAAP EPS estimate moves to $4.50 (+$0.02), largely reflecting the Q3 beat and lower interest expense from debt reduction.
For 2015 and 2016, we model non-GAAP EPS of $5.12 and $5.77, respectively, with generics (new launches and Red Oak), pharmacy benefits management strength, specialty, and reform helping to offset tobacco and competitive PBM pricing. Our capital deployment assumptions could prove conservative, particularly if M&A is pursued near term.
CVS trades at 16.7 times our 2015 non-GAAP EPS estimate, above the low- to mid-teens five-year trading range. Our new $95 price target (from $86) is based on a 16.5-times multiple on 2016 EPS, reflecting continued confidence in longer-term double-digit EPS growth targets.
Cowen and Company
CVS Health’s Q3’14 adjusted EPS of $1.15, excluding the loss on early extinguishment of debt in 2014 and a legal settlement gain in 2013, beat consensus of $1.13 and the guidance range of $1.11 to $1.14, with top line (sales) of $35.02 billion, up 9.6% year over year, modestly beating Street expectation of $34.72 billion.
PBM revenues of $22.53 billion, up 15.7% year over year, were slightly ahead of Street estimate of $22.41 billion, driven by growth in specialty including the acquisition of Coram and the impact of Specialty Connect, along with increased volume in pharmacy network claims.
Pharmacy network claims processed increased 4.3% year over year to 209.6 million, primarily due to net new business and growth in Managed Medicaid, but partially offset by a decrease in Medicare Part D claims. Mail decreased 1.3% to $20.7 million, driven by a decline in traditional mail volumes, but partially offset by growth in Maintenance Choice Program. Segment operating margin was down 32 basis points year over year to 4.8%, but was ahead of consensus of 4.6%. Segment operating profit came in at $1.09 billion, in line with Street estimate of $1.04 billion.
Revenues in the Retail segment increased 2.9% year over year to $16.75 billion, slightly ahead of consensus of $16.56 billion. Total comps increased 2.0% year over year vs. consensus of 0.9%, with prescription same-store sales up 4.8% and front-end same-store sales down 4.5%. Prescription sales were negatively impacted by about 190 basis points due to recent generic launches and by about another 190 basis points due to the implementation of Specialty Connect, which had a greater effect on revenues than prescription volumes due to higher dollar value.
Front-end sales were negatively impacted by about 480 basis points due to the exit of tobacco, as well as softer customer traffic, while partially offset by increase in basket size. Segment operating margin of 9.1% was up 45 basis points, in line with Street expectations. Operating profit of $1.53 billion was also in line with Street expectations.
Morgan Stanley & Co.
Following Q1-FY15 results, in which RPM International Inc. (RPM) reaffirmed full-year guidance and provided a $2.70 to $2.90 EPS outlook for FY16, we are revising our quarterly estimates for the remainder of FY15, as well as raising our FY16 estimates to account for accretion related to the reconsolidation of Special Products Holding Corp.
RPM reported somewhat mixed results for the first quarter, as it faced tough comparisons in its Synta and Kirker businesses, as well as slowing momentum in Europe. Excluding the contribution of Synta and Kirker, RPM’s consumer segment continued to perform well through the quarter, with core growth of 7% driving mid-double-digit EBIT growth in the teens. European weakness in RPM’s industrial segment, to which it is about 30% exposed, represents a reversal of RPM’s recent momentum in the region, and a contrast to the acceleration across RPM’s U.S. construction and industrial-related businesses.
RPM maintains full-year guidance of consumer sales +5-7%, industrial sales +6-7% and 9-11% EPS growth, implying a range of $2.38 to $2.42 per diluted share. While management highlights that European pressures are likely to persist, and be made worse by the strengthening dollar, the company points to the following positives underlying its full-year outlook: (1) Easier Synta comparisons through the last three quarters of the year; (2) further acceleration in its U.S. construction, chemical, flooring and industrial coatings businesses; and (3) more normal winter weather driving year-over-year improvements in the third quarter.
On a reconsolidated basis, excluding estimated transactions costs, RPM now expects FY16 diluted earnings per share to fall in a range of $2.70 to $2.90.
Model Update: As a result of Q1-FY15 results, we have slightly lowered our full-year earnings estimate, from $2.40 to $2.39 per diluted share. We maintain our Q2-FY15 estimate of $0.55 per share, while raising our estimates for the back half of the year on account of easier comps across RPM’s consumer businesses, and continued momentum in U.S. non-residential construction.
Our revised estimates also include adjustments for further European weakness and currency exposures. Our revised FY16 estimates reflect the benefits of RPM’s Special Products Holding Corp. reconsolidation, as well as a continuation of FY15 trends in U.S. non-residential construction.
Ghansham Panjabi, Ph.D.
Robert W. Baird
On an operating segment basis, RPM’s Industrial segment (63% of FY15 estimated sales) reported a year-over-year improvement (reported sales up 5.8% year over year), as volumes contributed positively for the fifth consecutive quarter and organic sales were up 4.5%.
Industrial volumes improved (up about 3.9%) in Q1-FY15 as a result of resurgent recovery in U.S. commercial construction demand (sealants/flooring/corrosion-control/concrete additives), which was partially offset by a slowdown in the European markets, most notably Germany and France, which experienced sales declines of mid-single digits. Meanwhile, foreign exchange (+0.1%) contributed positively and acquisitions (+1.3%) were a significant tailwind, noting that pricing also contributed about 0.5% to Industrial sales growth. As for profitability, operating margins decreased 10 basis points year over year, to 13.6%, as a result of lower sales volumes stemming from weakening demand in Europe.
Next, RPM’s Consumer segment (37% of FY15 estimated sales) reported a slight year-over-year sales decline (–0.8%) primarily as a result of lower organic sales (-2.1%). The company faced difficult year-over-year comparisons due to successful product introductions for its Synta and Kirker brands. More specifically, organic sales were down 2.1% as the company reported declining volumes (–3.1%) and higher pricing (approximately +1.0%), with acquisitions (+1.2%) and foreign exchange (0.1%) contributing positively to net sales.
New product introductions and improved U.S. housing turnover are expected to continue during Q2-FY15, and the Synta comparisons should rebound to positive, though the Kirker comparisons should remain difficult until 2H-FY15.