We are revising our estimates for CNC / MOH / HUM / WCG post 4Q18 results. We are also updating our price targets across our MCO / Drug Retail coverage universe to reflect 1) our revised earnings estimates laid out in this note and 2) the current S&P 500 market multiple of ~16x NTM earnings (up from previous 15x coming into 2019) given that our valuation methodology is based on relative P/E. See table below, links to all updated models and new PT build-up on page 2 for further details.
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Part 2 of the 2020 Medicare Advantage Advance Notice will be published sometime later this week, likely either Thursday 1/31 or Friday 2/1 (was released on Weds 2/1/17 and Thurs 2/1/18 despite CMS stating a 1/31 target last year). Based on “known” rate components we est. plan reimbursement should increase by ~2.9% ex-HIF – see Exhibit 2 on page 3 for details. Final rates are expected on 4/1/19 and rates have historically been more likely to improve than not vs. Adv Notice.
CVS noted lower brand inflation as a 2019 headwind at a recent investor conf (see our notes here and here) – inline with our concerns highlighted last year (see our PBM initiation) on rebate guarantee exposure. This follows on 3Q PBM guide down driven by higher guarantee payouts for 2018. From here questions naturally focus upon sizing the headwind for next year and read-thru to PBM peers.
We Remain Constructive on MCOs but See Risk/Reward More Balanced. MCOs have a strong fundamental backdrop and several tailwinds (HIF holiday / investment income) that support unique earnings visibility into 2019. That said, given current relative valuations appear to reflect much of this 2019 MCO earnings momentum we take a more measured view on the group as there are a number of potential factors that could weigh on sentiment and operating performance going into 2020. See PDF page 11 below for more details on these potential factors and please join our webcast this morning at 11am ET (click here to register) where we will discuss our views and answer questions.
WBA reported Q1 adj. EPS of $1.46, vs. WR/Consensus of $1.42/$1.43 with upside driven by $23m of other income and a lower tax rate. Adj. op profit of $1,732M (down 4.3% y/y) was below WR/Cons of $1,778M/$1,799M, with International Retail ($132M vs. WR/Cons of $209M/$214M, down 37% y/y) well below and Pharma Wholesale ($220M vs. WR/Cons of $233M/$239M, down 1.8% y/y) modestly below est. offset by solid results in US retail ($1,379M vs. WR/Consensus of $1,335M/$1,345M, flat y/y), potentially a positive read-thru for CVS. Note that the co. expected ~21-22% of FY19 earnings ($1.38-$1.44 at the mid-point of guidance) in 1Q and management reiterated EPS guidance of 7%-12% growth for FY19. WBA repurchased $912M of shares during 1Q, which leaves ~$2.1B for remainder of the year (~$3B target). Look for focus on outperformance in U.S. and International weakness on the call and please see our recent initiation for more on our views around WBA.
With WBA outperforming pharma supply chain peers meaningfully YTD and a relative lack of visibility on any meaningful improvement in fundamentals we initiate on the stock with a Peer Perform rating and $78 YE 2019 PT. Our 2019/2020 EPS estimates are slightly below consensus and while the co. has done a solid job of deploying capital to the benefit of shareholders via share repo/dividend while retaining optionality, we see better risk/reward opportunities within our coverage universe heading into 2019.
WBA reported 4Q18 results last Thursday (10/11/18) which, in our opinion, were somewhat underwhelming with sales largely in-line and Adj. Operating Profit below our expectations. Stepping back, WBA faces significant hurdles, as do other operators in the industry, in addressing changing consumer preferences, new competitive entrants, and the long-term relevance of the drugstore model. The veteran WBA team is aware of these challenges and for its part Walgreens is taking significant shots on goal by testing and expanding partnerships as it works to create more community healthcare hubs with its U.S. drugstores. While we agree with the premise of driving better productivity of the existing asset base, we believe the challenge is also going to be growing underlying operating profit as the company moves through this next phase of evolution. We see an outlook of higher investment and increased competition, all while continuing to deal with the challenges of reimbursement. Balancing a veteran team with cost-reduction acumen and a reasonable valuation, we remain Peer Perform.
CVS reported better-than-expected 2Q18 results this morning (8/8/18), with Adj. EPS of $1.69 exceeding our $1.61 estimate (which was in-line with Consensus) and CVS’ prior guidance of $1.59 to $1.64. On a consolidated basis, revenues slightly exceeded our forecast while Adj. operating profit of $2,373mm exceeded our $2,293mm estimate by approx. 3%. CVS narrowed its full-year guidance for Adj. operating profit growth to -0.75% to +0.75% (from -1.5% to +1.5%) and Adj. EPS to $6.98 to $7.08 from $6.87 to $7.08. CVS noted that its announced acquisition with Aetna is anticipated to close in 3Q or early in 4Q of this year. CVS rose 4.2% today.
WBA reported 3Q18 results this morning, and while Adj. EPS for the enterprise was better-than-expected, performance from the U.S. business fell shy of our expectations. But that wasn’t as tough a pill to swallow for the equity as was Amazon’s acquisition of PillPack this morning, signaling Amazon’s entrance into the dispensing market and the likely disruption to ensue, something we anticipated and included in our Amazon upgrade (Amazon 2028). We continue to believe the retail drugstore model remains very much in question. While WBA and CVS aren’t resting on their laurels and are attempting to address changing consumer preferences through partnerships and other initiatives, and in CVS’ case transformative M&A, changing these boxes into healthcare centers may have unintended negative consequences too (see back for more) all while the front-end continues to erode driven by Amazon and Dollar General. Balancing these clear negatives with a very low historical valuation and a management team with a proven track record of cost discipline and the willingness to deploy capital in value enhancing ways, we remain Peer Perform on WBA.
Amazon this morning, (06/28/18) announced that they acquired PillPack for an undisclosed sum. PillPack delivers medication in pre-sorted dose packaging and handles the logistics of refills and renewals. PillPack holds a pharmacy license in all 50 states, has the appropriate accreditations, and is in-network with most PBMs including Medicare Part D plans. The service is free, shipping is free, and customers are only responsible for copays.
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