CVS Health’s Pharmacy and Retail Businesses: Lower 3Q17 Margins
What was behind the 3Q17 gross margins fall?
As we discussed in the previous part of this series, CVS Health (CVS) reported a 135 basis point drop in its gross margin to 15.4% of sales. Driving this fall was a 90-basis-point fall in PBM (pharmacy benefits management) business margins and a 25 basis point fall in Retail/Long-Term Care business margins.
The PBM margin decline resulted from a shift in the timing of Medicare Part D profits into the next quarter, which drove gross profits down 8.4% during the quarter
The Retail/Long-Term Care gross margin fell mainly due to lower reimbursement rates. Loss of scripts from network changes along with reimbursement pressures lowered gross profits by 3.6% YoY.
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What drove down the operating margin of CVS’s segments
Operating margin at the PBM segment fell by 70 basis points to 4.1% while the operating profit fell 7.2% to $1.35 billion, reflecting a shift in Medicare Part D profits. Excluding the Medicare PDP business, PBM’s operating profit stood flat.
The Retail/Long-Term Care operating margin was down 110 basis points to 8%. Operating profit fell 14.3% to $1.55 billion, including $55 million in hurricane-related expenses.
Management narrowed its earnings guidance for fiscal 2017. It now expects EPS to lie in the $5.87–$5.91 range, compared to the $5.83–$5.93 guided earlier. The current guidance reflects year-over-year growth of 0.5%–1.25% in the company’s earnings.
The EPS guidance assumes 8%–8.5% growth in PBM sales with 6%–6.5% operating profit. For the retail business, management foresees 2.25%–2.75% fall in retail sales along with a 9.5%–10.25% fall in operating profit.
“Given our performance year-to-date and our confidence in our expectations for the remainder of this year, we are narrowing and raising the midpoint of our Adjusted EPS guidance for 2017,” commented Larry Merlo, President and Chief Executive Officer of CVS Health. “We remain committed to returning to healthy levels of earnings growth for the total enterprise, and the actions we have taken thus far this year, including our expanded partnerships and new PBM offerings, set us on the right track for growth.”
Investors looking for exposure to CVS Health could consider the Vanguard Consumer Staples ETF (VDC), which invests 4.3% of its portfolio in the company.