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Drivers That Impact CVS’s Pharmacy Services Segment

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Segment analysis: CVS Health’s Pharmacy Services segment

CVS Health (CVS) is projecting 2Q15 revenue growth between 11.25% and 12.5% for its Pharmacy Services segment, which provides pharmacy benefit management (or PBM) services. This implies sales of $24.3–$24.6 billion in the quarter.

In 1Q15, revenue for CVS’s Pharmacy Services segment rose 18.2% year-over-year to $23.9 billion. The upside to revenue was primarily provided by an increase in the number of healthcare claims processed and higher specialty pharmacy sales. Healthcare claims processed rose 11% to 230.8 million in the quarter. Specialty pharmacy sales rose 46%. Revenue from the average network claim increased by 2%.

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Integrated drugstore chain

CVS is the most integrated pharmacy chain in the United States. The company provides PBM services, operates a chain of almost 8,000 drugstores across the country, and owns about 1,000 clinics.

Pharmacy Services is CVS’s largest segment, clocking sales of $88.4 billion in 2014 before intersegment eliminations. The segment’s clients include employers, insurance companies, managed Medicaid plans, and other health plan sponsors. The segment’s PBM services include formulary management, helping design pharmacy benefits plans, providing Medicare Part D services, and operating mail order and specialty pharmacies.

Segment operating income grew 14.6% to $734 million in 1Q15 before intersegment eliminations. The segment’s operating margin fell slightly to 3.1% from 3.2% in 1Q14. Margins fell partly due to pressure on reimbursement rates. This was relieved by a higher generic dispensing rate (or GDR) of 83.5% compared to 82% in 1Q14 for the segment and purchasing economies.

Red Oak Sourcing, the 50-50 joint venture between CVS Health and Cardinal Health (CAH), is responsible for negotiating terms with generic suppliers. Red Oak is a key driver for bringing about purchasing economies for CVS.

Peer group performance

Express Scripts (ESRX), a CVS competitor in the PBM business, declared 2Q15 earnings on July 28. ESRX beat consensus Wall Street earnings estimates, reporting adjusted earnings per share (or EPS) of $1.44 versus the consensus of $1.40. However, the company missed revenue estimates, with adjusted claims down 1% to 321.2 million. But ESRX rose 1.4% to $92.38 on July 28 on upwardly revised full-year EPS guidance.

CVS is among the top five holdings in the Consumer Staples Select Sector SPDR ETF (XLP) with a 7.1% weight. CVS is also included in the portfolio holdings of the SPDR S&P 500 ETF (SPY) with a 0.7% weight.

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