Double Dose Of Good News From CVS Health

CVS Health (CVS) finished 2022 in strong fashion. Indeed, Q4 revenues grew 9.5% from the prior year to $83.85 billion and came in over $7 billion above the $76.32 billion consensus estimate as the company continued to benefit from solid growth across all of its businesses. As was the case for much of the year, this was led by its Pharmacy Services segment where greater volume of pharmacy claims, growth in its specialty pharmacy operations and brand inflation drove an 11.2% rise in revenues to $43.75 billion. CVS’s smaller Health Care Benefits (HCB) and Retail/LTC segments also continued to perform well with revenues in the former up 11.3% to $23.03 billion on solid demand for all of its products and the latter enjoying a 4.0% top-line lift to $28.18 billion thanks to greater prescription volumes and front store sales, a favorable pharmacy drug mix and brand inflation.

The higher revenues, better purchasing economics in Pharmacy Services and the benefits of previously implemented business initiatives in Retail/LTC helped make up for the pressure put on profit margins from the anticipated decline in COVID-19 vaccinations and diagnostic testing, greater incremental investments CVS is making to support growth and a higher effective tax rate. As a result, adjusted earnings rose by 0.5% to $1.99 per share. That, too, was better than the 3.0% decline to $1.92 analysts had been projecting.

Despite this, CVS simply reiterated its previously provided outlook for adjusted earnings of $8.70-8.90 per share for 2023. At the midpoint, this indicates growth of just 2.4% from the $8.69 it earned in 2022 and primarily reflects the fading of the net favorable impact of COVID on its business. The good news is its operations are still expected to produce an impressive $12.5-13.5 billion in cash flow. And with strong cash generation like this, it’s not hard to see why CVS remains optimistic in its ability to retain its investment grade credit rating even after the additional leverage it expects to incur once its previously announced $8 billion acquisition of leading health risk assessment, provider enablement and value-based care provider Signify Health, Inc. (SGFY) closes (slated for Q2) and it also swallows Oak Street Health (OSH)—a leading multi-payor, value-based primary care company helping older adults stay healthy and live life more fully—for approximately $10.6 billion by the end of the year, which was concurrently announced this morning.

In fact, we believe the latter announcement is the bigger reason why CVS’s stock bucked today’s market selloff and closed over 3% higher. Specifically, while the $11 billion price tag may seem high for a company that expects to lose between $225 million and $265 million on an adjusted EBITDA basis this year, that’s solely the result of the elevated costs required to support OSH’s fantastic growth and aggressive expansion efforts. Indeed, due to the success it has had in reducing the cost of care for its clients through its value-based approach, OSH has been able to more than triple its medical center count over the past three years—from 51 at the end of 2019 to 169 currently. As a result, revenues are likely to have quadrupled from $557 million in 2019 to over $2.1 billion last year.

With the number of locations projected to roughly double to more than 300 locations over the next four years, OSH’s top line growth should remain exceptionally strong. More importantly, as these newer clinics scale and reach the level of profit contributions in line with OSH’s more mature and full-scaled locations—which are expected to produce $6.7 million and $8.5 million in EBITDA on an individual basis this year—CVS thinks all of these locations have the potential to contribute about $7 million annually to adjusted EBITDA by 2026. Combined with the $500 million in cost synergies the transaction is also projected to yield over time—stemming in part from the ability to leverage CVS’s wide reach and the fuller value-based primary care capabilities afforded by the acquisition—this implies a potential EBITDA contribution of more than $2 billion by 2026, or just over five times the purchase price. This, along with the projected contributions from the pending SGFY transaction, is why even with the previously disclosed Medicare Stars Ratings headwind in 2024 and a key contract loss, CVS sees adjusted earnings growing to about $9.00 in 2024 and $10.00 in 2025. If so, today’s bounce in its stock should be a harbinger of further gains ahead.