CVS announced this morning (01/18/19) that WMT will continue to participate in the CVS Caremark networks. Recall that on Tuesday (1/15), CVS announced the termination of contract (Medicaid & Commercial only) with WMT due to a dispute over pricing/reimbursement. We expected the potential disruption to be manageable even if WMT were to opt out from the networks. The companies stated that they “have reached a mutually agreeable solution” on “fair and equitable terms” without disclosing the financial terms of the new contract. We believe less than 4% of CVS’s scripts are filled in Walmart, given higher Caremark member penetration in CVS’s own retail pharmacies and WMT’s skew to cash customers.
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Following UNH’s earnings report and conference call this week, we are revising our outyears estimates upwards to reflect UNH’s ability to manage through potential HIF headwinds in 2020+, driven by partially the multi-year medical cost / G&A savings noted at the 2018 Investor Day and continued improving performance across Optum. Our ‘19/’20/’21 est. are now $14.60 / $16.50 / $18.70 vs. previous $14.57 / $16.10 / $17.96 – generally in-line w/consensus. PT is now $276 off new 2020 EPS of $16.50 assuming a 10% premium to S&P multiple of ~15x / target relative multiple of 16.7x.
Yesterday (01/16/19) HCA received regulatory approval from the North Carolina Attorney General for the acquisition of Mission Health. According to the agreement with the NC AG HCA will commit to provide services at local hospitals for at least 10 years, build new N.C. facilities, and support community service programs sponsored by Mission. The company also agrees to be subject to legal actions from the AG’s office should it break its commitments. We note that the Federal Trade Commission still needs to give approval for the deal to consummate. Mission expects the deal to close Jan. 31. We note this date may or may not have contemplated the continued government shutdown.
CVS announced that WMT has opted to leave the CVS Caremark commercial and Medicaid retail networks in a dispute over pricing/reimbursement. CVS does not expect the network termination to have a material impact on 2019 financial results as the co. focuses on transitioning impacted members to other network pharmacies. CVS has requested WMT to fill prescription for its members through the end of April (from current Feb 1st) and remains open for further negotiations to reach an agreement on pricing. Recall that in 2012, Walgreens terminated its retail network contract with ESRX, citing reimbursement rate cuts as one of the reasons. In its earnings calls in 2012, ESRX noted that the termination “wasn’t a big negative” and the clients had “virtually no disruption”. Arguably, the potential disruption caused by the WMT-CVS termination should be less, given WMT’s current pharmacy market share of ~4-5% (on rev basis) vs. ~15-16% market share of Walgreens at the time of the termination. We believe less than 4% of CVS’s scripts are filled in Walmart, given higher Caremark member penetration in CVS’s own retail pharmacies and WMT’s skew to cash customers.
On the Q4 earnings call UNH stressed the MLR miss in the quarter was almost entirely due to Medicaid performance. The co noted 2018 saw a pullback in TANF Medicaid performance in 5 states but wouldn’t talk to which states these are other than to say none of their peers are in all 5 and IA is clearly one of them. UNH remains focused on trying to move Medicaid business back to its target margin range 3% to 5% (more below) and also stated that performance in 2H improved vs. 1H but still not up to par. The co reiterated the MLR of 81.6% for FY18 and UHC operating earnings of $9.1B were in-line with the guidance laid out at November I-day. Additionally, UNH noted that commercial MLR trajectory through the year was steeper in 2018 vs. previous due to more high deductible products.
UNH reported 4Q’18 adj EPS of $3.28, above Wolfe/Cons $3.24/$3.21 as a strong top-line and lower than expected SG&A offset higher MLR / lower inv income in the qtr. Total rev of $58.4B (up 12.2% y/y, ~10.5% ex-HIF) was above Wolfe/Consensus of $58.1B/$58.0B w/SG&A of 15.1% for the year vs. guide of ~15.3% and MLR at 81.6% for the year vs. 2018 guide of ~81.5% at investor day. 2019 guidance reaffirmed at adjusted EPS of $14.40-$14.70 (Cons pre earnings was $14.62, implying ~13.5% growth off FY18 earnings of $12.88). We expect the focus for investors to be drivers of elevated MLR and read-thru’s for rest of MCOs with our view being UNH is likely seeing some impact from increasing seasonality as well as the typical white noise in MLR that ensues when medical cost trend is fairly stable rather than declining – which is the feedback we have gotten from NFP checks.
Earlier today (1/14/2019) CMS released the January enrollment data for Medicare Advantage providing the first look of how the fall 2018 Annual Enrollment Period played out and thus far it looks like growth is mixed across the group with AET (CVS) being a notable outperformer. While we note that January enrollment in general has become a bigger piece of annual growth (January was ~20% of total in 2015 growing to ~40% in 2018) a majority of the growth is still yet to come and the return of the Open Enrollment Period in 2019 (seniors can shift from plan to plan once during the first three months of 2019) may also impact enrollment #s unexpectedly. While co. specific growth is too early to call, the Jan enrollment paints a picture of large for-profit plans taking significant share again and the Feb growth report next month will bring co. specific and industry growth into greater clarity.
We are updating our CVS/AET pro-forma model to reflect additional information provided by the co. on the transaction and FY19 headwinds/tailwinds discussed at a recent investor conference. Our new FY19 EPS of $7.20 is ~3.5% below the current Consensus est. of $7.46, with the decline vs. our previous $7.68, primarily driven by (1) assumed post-deal investment spending of $250m or $0.14 (2) incremental rebate guarantee payouts of $300m or $0.17 (see our previous notes on the topic here and here) and (3) a slightly more conservative ramp on synergies from $350m in Year 1 to now assuming $250m in Year 1, a $0.06 impact. See pg. 3 for a summary of our pro-forma model and this link for our working CVS model. Recent conversations indicate investor expectations for initial guidance are all over the board, ranging from $7.00 - $7.50 with the recent stock price action clearly indicating a fair amount of angst here.
CVS’s recent commentary on rebate guarantees at a competitor conference forces questions for peers. As discussed in our note last night (1/8/19), CVS management has been the most vocal about the headwinds from lower branded drug price inflation to contracted rebate guarantees. Our industry checks indicate the practice has been wide-spread across the industry, begging questions around exposure at peers ESRX and OptumRx. As we discuss below we think the exposure at OptumRx should be much more moderate for a couple of reasons while ESRX is likely similar but potential offsets have left us more comfortable here while also acknowledging the topic as one of the main risks to our Outperform rating on post-deal CI.
At an investor conference, CVS highlighted muted brand inflation as one of the headwinds in FY19 and expects to see impact on client commitments in the PBM business, including guaranteed rebates. We spent considerable time in our PBM launch and webcast discussing our concerns around rebate guarantees going into 2019. Effectively PBMs have contractually guaranteed clients improving absolute $ rebates and this could be a risk should brand pharma gross price inflation remain moderate, leading to less $ rebates from manufacturers. Many 2019 contract terms were underwritten in 2015-2017 when brand inflation was higher and recent moderation here is likely to cause a shortfall in the gross rebate earned from manufacturers vs. what was guaranteed in the client contracts. See Pages 3-5 for our initiation slides on rebate guarantees.
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