CVS CAREMARK CORP
CREDIT RESEARCH AND ANALYSIS
Statement Date  09/30/2009
 
CVS CAREMARK CORP
 		GCS ANALYST RATING: C- (MODERATE RISK)
ONE CVS DR GCS OUTLOOK: NEGATIVE
WOONSOCKET RI, USA 02895
PHONE: 401-765-1500 ISSUE DATE: Sep 30, 2009
WEBSITE: HTTP://INFO.CVSCAREMARK.COM/ Stock Symbol: CVS
KEY MANAGEMENT: < SEE DETAIL > INDUSTRY ANALYST: JOHN ANALYST
< VIEW SYNOPSIS >   Analyst Commentary Nov 17, 2009     
"CUTTING OUTLOOK ON LOST PHARMACY SERVICES BIZ"
We are leaving our moderate risk, 'C' credit rating on CVS Caremark intact, but we are reducing our outlook to a new level of negative (from a previous level of stable) to denote the possibility of a future downgrade. On the surface, the latest numbers reported in the firm's third quarter and nine-month results are anything but troubling. In retail specifically, the company has enjoyed a nice spurt in its pharmacy comps and has managed to keep front-end business growing, albeit at low-single digit levels.

However, the real issue relates to business drops for fiscal 2010 in the pharmacy services segment that will impact results next year. In aggregate, while this segment has booked $1.4 billion in new business wins, it has suffered $4.5 billion in losses. The losses relate to about $1.7 billion tied to 500,000 dual eligibles (Medicare Part D beneficiaries who are also eligible for Medicaid), and the bulk of the remainder comprised unrenewed contracts with the states of New Jersey and Ohio, Coventry Healthcare, and Chrysler's retirees. Pricing, customer service, and preference for working with a smaller PBM that did not also own drugstores were identified as reasons for these customer departures. These losses essentially wipe out any hope of the segment growing its operating profit in fiscal 2010; a more realistic assumption for this segment could involve its operating profit declining 10% to 12%. Firmwide results will be buffered by the retail segment, which should augment its operating income by 13% to 16% in fiscal 2010. Thankfully, the balance sheet provides an ample cushion to fully support the business while management works to restore higher levels of growth in its pharmacy services segment.

As of September 30, 2009, CVS operated 7,008 retail drugstores across 41 states and Washington D.C. under the CVS or Longs Drug banners. The firm currently operates 569 retail health care clinics in 25 states under the Minute Clinic name (554 of them are located in CVS stores). As a reminder, the firm's fiscal year now ends on December 31st as opposed to the Saturday nearest to December 31st. The recent third quarter ended included 92 days this year versus 91 last year; however, the nine-month figures for fiscal 2009 and fiscal 2008 each include 273 days.


OPERATING PERFORMANCE: 9 MONTHS ENDED SEPTEMBER 30, 2009

$ in millions, 39 weeks endED 9/30/2009 YOY Var. 9/27/2008
Total Sales
 $72,906.9 15.1%
 $63,329.7
Operating Profit
 $4,542.9
 5.3%
 $4,314.4
Net Income
 $2,646.2 17.2%
 $2,259.3
Gross Margin
 20.3%
 (31 bps)
 20.6%
SG&A Burden
 14.1%
 29 bps
 13.8%
Operating Profit Margin
 6.2%
 (58 bps)
 6.8%
Return on Sales
 3.6%
 6 bps
 3.6%
During Q3 2009, CVS Caremark reported revenue growth of 18.1% to $24.6 billion, which was comprised of retail segment growth of 17.9% to $13.6 billion and pharmacy services segment growth of 23.4% to $13.0 billion. For the nine months ended September 30, 2009, the firm's revenues rose 15.1% to $72.9 billion as retail segment revenue improved 16.3% to $40.9 billion while pharmacy services segment sales grew 17.5% to $37.6 billion. Simply adding the segment totals together to reconcile the firm's total revenue base also requires accounting for intersegment eliminations of $2.0 billion during Q3 2009 and $5.6 billion on a year-to-date basis.

Same store sales, which will only begin to include the Longs stores in November 2009, rose 5.7% during Q3 2009 and increased 5.0% during the first nine months of fiscal 2009. Third quarter comps performance was driven by 8.0% pharmacy growth and 0.8% front-end growth. Year-to-date comps have seen a 6.7% rise in pharmacy coupled with a 1.5% rise in the front-end.

During the last quarter ended, the firm's pharmacy services revenues broke down in the following manner: $8.8 billion of retail network, $4.2 billion of mail service, and $91.6 million of other. For the nine months ended September 30, 2009, the firm's pharmacy services revenues broke down in the following manner: $24.9 billion of retail network, $12.4 billion of mail service, and $263.5 million of other. This unit processed a total of 162.9 million and 490.4 million pharmacy claims during Q3 2009 and fiscal 2009YTD, respectively, with about 90% of them coming from retail and the remaining 10% coming from mail order.

A couple of new reporting changes are worth noting. First, when pharmacy services customers elect to pick-up their maintenance prescriptions at retail segment stores instead of receiving them through the mail, each segment now records the revenue, gross profit, and operating profit on a standalone basis and corresponding intersegment eliminations are made. Previously, each segment only recorded the revenue on a standalone basis. Secondly, certain administrative expenses that benefit both segments equally (such as executive management, legal, compliance, corporate relations, etc.) were reclassified out of the pharmacy services and retail segments into a new corporate segment.

CVS Caremark's gross margin fell 75 basis points in Q3 2009 and declined 31 basis points on a year-to-date basis, both to 20.3%. Pressure upon retail segment gross margins (down 103 basis points in Q3 2009 and down 43 basis points year-to-date) was related to third party reimbursement rates, more significant levels of promotional items being purchased by customers, which offset the benefit of generic drug sales. Pharmacy services segment gross margins (down 54 basis points in Q3 2009 and down 56 basis points year-to-date) were off due to both pricing concessions on a few large contracts and a change in the revenue recognition method for Rx America. Generic drugs continue to be very prevalent, representing 69.6% of scripts dispensed in the retail segment and 67.9% of scripts dispensed in the pharmacy services segment during the first nine months of 2009. Private label penetration (excluding Longs) rose 120 basis points to 17.0% of front-end sales during Q3 2009. Private label penetration in the Longs stores climbed to 11.0%, lower than we'd like to see but much improved from prior levels. The firm's SG&A burden was down 8 basis points to 14.0% during Q3 2009, but was up 27 basis points to 14.1% on a year-to-date basis; despite integration costs surrounding Longs and RxAmerica, the firm exhibited strong expense control in the most recent quarter ended. CVS Caremark's operating margin came in at 6.4% for the third quarter and 6.2% for the year-to-date period, down 58 basis points and 68 basis points respectively. The firm's operating margin results were indicative of pharmacy services margin lost on the gross line basically falling to the operating line and some headway being made on the retail side of its business. Specifically, pharmacy services operating margins fell 55 basis points during Q3 2009 and declined 67 basis points thus far this year. Conversely, retail operating margins fell 81 basis points during Q3 2009 and dipped 50 basis points on a year-to-date basis.

SEGMENT ANALYSIS: 9 MONTHS ENDED SEPTEMBER 30, 2009

$ IN MILLIONS, 39 WEEKS ENDED
 9/30/2009
 YOY VAR.
 9/27/2008
Retail Pharmacy Segment


-Net Revenue (1)
 $40,899.5
 16.3%
 $35,158.4
-Gross Profit
 $12,081.6
 14.7%
 $10,536.4
-Operating Profit
 $2,938.1 8.8%
 $2,701.1
Pharmacy Services Segment


-Net Revenue (1)
 $37,573.0
 17.5%
 $31,984.9
-Gross Profit
 $2,760.1
 9.1%
 $2,530.6
-Operating Profit
 $2,033.0 4.5%
 $1,946.0
(1) - before intersegment eliminations of $5,565.6 million in fiscal 2009YTD and $3,813.6 million in fiscal 2008YTD.

LIQUIDITY & FINANCIAL STRUCTURE

On September 30, 2009, CVS had more than $1.1 billion of cash and equivalents on its balance sheet. Three unsecured back-up facilities worth $1.4 billion, $1.3 billion, and $675 million provided the firm's liability-side liquidity; a fourth facility in the amount of $675 million was permitted to expire in June 2009. As of September's end, CVS Caremark had no direct borrowings against these revolvers. The bank lines did however backstop commercial paper borrowings of $1.1 billion; commercial paper usage continues to come down on a sequential quarterly basis with the firm having paid off $1.4 billion of C/P borrowings since fiscal 2008's end. Although not cited in the 10-Q filing, we estimate CVS Caremark to have had approximately $7.0 million of outstanding L/Cs as of the fall statement date. Taking into account the above figures, aggregate availability on these lines totaled about $2.27 billion as of September 30, 2009.

Cash flow from operations of $2.2 billion rose only 2.4% but was adequate enough to cover nearly $1.8 billion of capital expenditures in the first nine months of fiscal 2009. The limited year-over-year growth of CVS Caremark's operating cash flow was related to higher income taxes paid, offset by higher bottom-line profits. While receivables and inventories reduced operating cash flow more so than they did last year, payables benefited operating cash on a year-to-date basis while lowering it last year. Looking at the cash flow statement, it appears that CVS Caremark has utilized sale leaseback proceeds to help fund its capital investment program. On a year-to-date basis, sale leaseback proceeds had risen 280% to $748.2 million. In terms of specific store-related activity, the firm has opened 155 new stores, relocated 101 stores and 2 specialty pharmacy stores so far this year. Additionally, 70 retail pharmacies, 8 specialty pharmacies, and 1 mail order pharmacy were closed during the nine months ended September 30, 2009.

Similar to actions taken in March and July of this year, CVS Caremark took the opportunity to issue longer-term financing in September to replace short-term borrowings. To this end, the firm issued $1.5 billion of 6.125% unsecured senior notes that do not mature until September 2039. Proceeds were used to, among other things, pay down another $200 million of commercial paper borrowings in Q3 2009 and pay off $650 million of unsecured notes. Back in March 2009, CVS issued $1.0 billion of 6.6% unsecured senior notes due March 2019 to pay off the remaining borrowings from its $1.2 billion bridge loan facility that was used to finance the Longs Drug Stores purchase and also pay down commercial paper borrowings. Then in July 2009, CVS Caremark issued another $300 million of unsecured floating rate senior notes due January 30, 2011 for general corporate purposes.

CVS Caremark's total debt has escalated 23% to nearly $12.0 billion on a year-over-year basis. Roughly $3.2 billion of the firm's debt is classified as current; given the creditworthiness of this retailer, we are not concerned about the firm's ability to either pay down or refinance these borrowings. The company's debt-to-capitalization of 25% is up from the 22% level seen last fall. CVS Caremark's tangible net worth, which returned to positive territory this summer, returned to a deficit level of $151.1 million; on a year-over-year basis, this figure still compares favorably with the $386.2 million deficit seen in September 2008. Driving the tangible net worth erosion on a sequential quarterly basis was an acceleration of share purchase activity, as more than $1.5 billion of its own common stock was bought back in Q3 2009. Cash dividend payments totaling $330.8 million were up 22% through the third quarter's end.

Jonathan Kanarek, CFA
Director of Analysis
< Detailed Financials > Profitability & ROI Analysis  
9 Months Ending ($ in Thousands) Sep 30,2009
( 10Q )		 Sep 27,2008
( 10Q )		 YOY VAR
(% / bps)		 Sep 29,2007
( 10Q )		 YOY VAR
(% / bps)
NET SALES $ (YTD) 72,906,896 63,329,700 15.12 % 54,387,100 16.44 %
GROSS MARGIN % (YTD) 20.32% 20.63% - 31 BPS 21.43% - 80 BPS
SGA MARGIN % (YTD) 14.09% 13.82% 27 BPS 15.33% - 151 BPS
OPERATING MARGIN % (YTD) 6.23% 6.81% - 58 BPS 6.10% 71 BPS
NET PROFIT $ (YTD) 2,646,200 2,259,300 17.12 % 1,822,000 24.00 %
 
RETURN ON SALES % (YTD) 3.63% 3.57% 6 BPS 3.35% 22 BPS
RETURN ON ASSETS % (LTM) 5.82% 5.49% 33 BPS 4.08% 141 BPS
RETURN ON EQUITY % (LTM) 10.09% 9.11% 98 BPS 6.83% 228 BPS
9 months ending Sep 30,2009 2009 2008 YOY VAR 2007 YOY VAR Weight %
GCS FINANCIAL SCORE 3.26 3.19 -0.07 3.00 -0.19 100%
GCS RATING C- C+   B-    
GCS OUTLOOK NEG STA   STA    
9 months ending Sep 30,2009 2009 2008 YOY VAR 2007 YOY VAR
THRESHOLD 3.29 3.12 -0.17 3.23 0.11
PEER SCORE 3.21 3.33 0.12 2.47 -0.86
  GCS COMPOSITE SCORE 3.26 3.19 -0.07 3.00 -0.19
Threshold Indicator Groups    
LEVERAGE INDICATORS 3.24 3.05 -0.19 3.08 0.03
PERFORMANCE INDICATORS 2.74 2.74 0.00 2.87 0.13
LIQUIDITY INDICATORS 4.92 4.37 -0.55 4.65 0.28
  THRESHOLD 3.29 3.12 -0.17 3.23 0.11
Peer Indicator Groups    
INDUSTRY IMPACT 3.21 3.33 0.12 2.47 -0.86
INSIGHT 0.00 0.00 0.00 0.00 0.00
  PEER SCORE 3.21 3.33 0.12 2.47 -0.86
$ In thousands Sep 30, 2009
TOTAL REVENUE (LTM): $97,049,104 STOCK SYMBOL: CVS 
SALES GROWTH (YTD): 15.12% SHARE PRICE: (Dec 15, 2009)  $31.76 
COMP STORE SALES (3 QTR): 5.70% 52 WEEK HIGH/LOW: $38.01 / $23.98 
STORE COUNT: (Sep 30, 2009) 7,008 MARKET CAP: $44,798,846  
TANGIBLE NET WORTH: $-151,503 S&P RATING (LONG TERM): BBB+
TNW CHANGE (YOY): 0 S&P OUTLOOK: NEGATIVE
< FACILITY DETAIL > Updated Bank Reference Nov 16, 2009
FACILITY TYPE: REVOLVER - UNSECURED CASH BORROWINGS: $1
ADMINISTRATIVE BANK: BANK OF NEW YORK MELLON LETTER OF CREDIT USAGE: $7,000,000
CREDIT FACILITY AMOUNT: $1,400,000,000 CREDIT FACILITY AVAILABILITY: $293,000,000
MATURITY DATE: 05/12/2011 COVENANT COMPLIANCE: IN COMPLIANCE
< SEE ROLLING TRADE > Recent Trade Survey Summary  
Reference Date #Suppliers Owing Past 31-60 Past 61-90 Over 90 Pay Index ADP
Nov 2009 673 54,677,437 0.78% 0.22% 0.90% 0.00 0.00
Oct 2009 685 67,651,133 0.21% 0.14% 0.92% 15.00 29.00
Sep 2009 672 56,910,382 0.50% 0.20% 1.30% 0.00 0.00
Aug 2009 674 54,639,156 0.86% 0.51% 1.25% 0.00 0.00
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