Pharmacy network changes impact CVS’ profitability
As we discussed previously in this series, 2017 has been a challenging year for CVS Health (CVS). The company’s retail pharmacy sales were hit after losing prescription market share to Walgreens.
CVS recorded a decline in gross profit in its Retail division for the first time in the last several quarters. Its gross profit fell 2.7% and 2.8%, respectively, during the first two quarters of fiscal 2017.
CVS’s Retail segment’s operating profit fell 11.9% and 12.7% in 1Q17 and 2Q17, respectively. This trend would lead to 10.8% and 7% declines in its 1Q17 and 2Q17 consolidated operating profit, respectively. Fiscal 2017 is likely to be the first year in the last ten years when CVS could report an operating profit decline.
Despite the recent pressure on margins, CVS recorded better profitability than competitor Walgreens Boots Alliance (WBA). The company recorded a trailing-12-month operating margin of 5.3% compared to 4.8% for Walgreens.
Comparing near-term earnings potential of the two companies
With respect to the short-term earnings potential, Walgreens looks a bit better. Wall Street analysts are projecting 11.2% earnings growth for Walgreens over the next year. In comparison, CVS Health’s earnings could increase ~4.4% over the same period.
While Walgreens’ earnings could benefit from its partnerships with pharmacy benefit managers and insurance companies, as well as ongoing cost control initiatives, CVS Health’s earnings would be negatively impacted by the prescription market share loss.
However, the scenario could change completely if Internet giant Amazon (AMZN) enters the prescription drug market. Read the next section to see how the news of Amazon coming to the pharma market have impacted CVS and WBA so far.
Investors looking for broad-based exposure to Walgreens and CVS can consider the VanEck Vectors Retail ETF (RTH), which invests ~9% of its portfolio in the two companies.