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Practice Management > Building Your Business

Healthy Prospects

By Ed McCarthy, CFP, RICP

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Charles Rhyee
Cowen & Company
[email protected]
646-562-1376

We are positive on CVS Health in the near term for its strong pharmacy benefits management (PBM) business and Hepatitis C sales, as well as in the long-term for its positioning on health reform with its integrated PBM/retail business model. We believe management is steering the company in the right direction with a number of long-term growth drivers such as the Cardinal Health/CVS sourcing joint venture, the growing clinics business, Pharmacy Advisor and Coram. We still see favorable risk/reward and think it should be a core holding for any healthcare investor.

While investors are concerned with margins in 2016, and particularly whether reimbursement rate pressure is getting worse than expected, management does not see [them] as any worse than [its] own estimates. Given [its] track record, we are inclined to believe this and note margins should be coming down, primarily due to faster growth from low margin areas and some timing issues that should reverse in 2017.

Despite disappointing the high bar that has been set, it’s important to remember CVS is still meeting its long-term target of 10-14% growth with its preliminary 2016 guidance. The growth strategy remains focused on growing covered lives in the PBM and retail share through their integrated operations to win as an enterprise, and the move to digital outreach also helps to engage and offset the ongoing margin pressure faced by the business.

Additionally, disciplined capital allocation [strategies] as a mix of dividends, buybacks and mergers & acquisitions remain positive drivers as well. CVS remains a strong operator and steward of capital, with $4 billion in share repurchases expected to be completed in 2016, and remains on track to hit its targeted dividend payout ratio of 35% by 2018.

While the adjusted debt/earnings before interest, taxes, depreciation and amortization (EBITDA) ratio has risen a bit over 3.2 times due to recent incremental deal-related debt, management is focused on getting back to its 2.7 times target, which its strong cash flow generation should enable. For 2015, management expects free cash flow of $5.9 billion to $6.2 billion, and we would expect modest growth on this strong base in 2016 as well.

We maintain our 2015 adjusted EPS at $5.18 but lower out 2016 adjusted EPS estimate to $5.78 from $5.98. We also lowered our price target to $109 from $113 based on our revised five-year discounted cash flow [analysis], which implies shares can trade at 18.9 times our 2016 adjusted EPS estimate of $5.78.

John W. Ransom
Raymond James
800-248-8863

We reiterate our outperform rating on CVS Health shares following in-line 3Q15 results … Rather than focus on the quarter, we believe it is more prudent to address what may have changed since we last addressed CVS’ out-year growth on Sept. 23.

We now model $1.53 in 4Q15 EPS (+$0.02), reflecting $5.16 in 2015 estimated EPS (unchanged), which is consistent with management’s $5.14-$5.18 outlook. Note that our prior model assumed a Dec. 31, 2015 Omnicare (OCR) deal close, making comparisons less comparable.

In 2016, we now model $10.8 billion in EBIT (-$0.4 billion) and $5.85 in EPS (-$0.15); this compares to management’s $5.68-$5.88 preliminary 2016 outlook. Our 2016 EPS estimate contemplates 4% organic EBIT growth, unchanged assumptions for OCR and Target, and a smaller benefit from 2016 net new business.

CVS trades at 16.9 times our 2016 non-GAAP EPS estimate, slightly above its historical spread relative to the S&P 500. Our $120 price target is based on a 20.5 times multiple on 2016 EPS, reflecting continued confidence in longer-term double-digit EPS growth targets.

Ghansham Panjabi, Ph.D.
Robert W. Baird & Co.
[email protected]
214-373-2955

Consolidated revenue for RPM International (RPM) improved moderately during 1FQ16 (quarter ended Aug. 31, 2015) as sales declines in industrial (–4.5%) and in consumer (–8.0%) were offset by the addition and resegmentation activities in the new specialty segment (+130.7% year over year).

Substantial North American weather-related headwinds were unfavorable (particularly for consumer) during 1FQ16 and foreign exchange (FX), both translational and transactional, negatively affected sales/profits.

Overall organic sales were up approximately 0.2% (volume +0.2%/price flat) during 1FQ16, while mergers and acquisitions contributed positively (+9.9%), noting that FX was unfavorable (–6.9%). Meanwhile, on an adjusted basis overall profitability declined modestly by 70 basis points year over year to 12.9% (EBIT margins).

RPM’s board of directors approved the separation of the company’s RPM2, reconsolidated Specialty Products Holding Corp. (SPHC) and other specialty businesses, to create the specialty products group operating segment. The businesses in this segment are characterized by having leadership positions in niche markets that traditionally do not compete with RPM’s normal peer group. The specialty businesses include fluorescent pigments, fire/water damage restoration equipment, specialty original equipment manufacturer (OEM) coatings, and edible coatings for food/pharmaceutical uses.

As of 1FQ16, the industrial segment represented 53% of consolidated RPM sales, with consumer (32% of sales) and specialty (15% of sales) rounding out the remainder. While SPHC sales are U.S. centered, the remainder of the specialty segment are split approximately 50/50 between U.S. and foreign sales, leaving the segment exposed to FX fluctuations.

Meanwhile, year-over-year organic sales improvement in the segment stemmed from slight volume gains (+0.6%) and flat pricing, while acquisition activity (+141.7%) vastly outweighed FX headwinds (–11.6%). In terms of profitability, the segment’s EBIT margins declined 610 basis points year over year (to 15.3%) due mostly to the lower margin nature of the SPHC businesses and FX dynamics.

Finally, as for the outlook, management revised its FY16 EPS forecast, which is now expected at approximately $2.50 (from $2.55), with management noting that the lowered guidance reflects incremental FX headwinds and an expected recovery in the consumer segment (post-detrimental 1FQ16 weather). Also, management expects SPHC to contribute $0.15 in EPS.

Moreover, the company expects consumer sales to increase 5% to 7% and industrial sales growth is now expected in the low-single-digit range, while specialty segment sales are expected to grow in the low- to mid-single digit range excluding acquisition activity.

RPM expects to benefit from the re-consolidation of the full $400-plus million SPHC contribution to sales in addition to the U.S. commercial construction recovery, which are offsetting FX difficulties in Europe, Brazil and South Africa. European demand is expected to remain positive during FY16, with the global sales strength highlighting the stable overall sales base driven by two different end-market cycles.

RPM noted that management expects to experience a tailwind from lower raw material costs, although FX headwinds (both translational and transactional) will eat into raw material benefits.

RPM International reported diluted 1FQ16 EPS (ended Aug. 31) of $0.74—below consensus of $0.82 and versus $0.73 earned during the 1FQ15 period.

Vincent Andrews

Morgan Stanley & Company

www.morganstanley.com

RPM International management lowered fiscal year ‘16 guidance to $2.50 versus the previous expectation of $2.55. The reduction includes a lower sales outlook in the newly reorganized Industrial segment of low single digits (versus 8-10% previously), while specialty segment sales are expected to grow [in the] low-to-mid-single-digit [range] in local currencies excluding acquisitions.

Including the newly separated specialty segment, sales increased 9.4% year over year, which compares to our estimate of 8.5%. The segment operating margin of 13.3% compares to [our estimates of] 14.3% and 13.6% in the prior year.

The company highlighted continued momentum in U.S. commercial construction, offset by weaker sales into the energy sector. European and Brazilian sales declined 12.9% and 21.0% respectively, but were up 3.3% and 16% in constant currency dollars.

RPM introduced a third reportable business segment, which combines the former RPM2 industrial operating segment and the former SPHC operating segment into a single operation called the Specialty Products Group. Both of these businesses were formerly incorporated into the company’s Industrial segment.

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