Fitch Ratings affirms CVS Caremark's ratings at BBB+; outlook stable
December 7, 2011
– Fitch Ratings has affirmed its ratings on CVS Caremark Corp. CVS +0.11% . The Rating Outlook is Stable. CVS had $10.8 billion in debt outstanding at Sept. 30, 2011. A full rating list is shown below.
The affirmations reflect the company's relatively steady credit metrics and strong liquidity position. Fitch expects CVS to manage its credit profile and capital allocation within the context of maintaining its publicly stated adjusted debt/EBITDA (including NPV of lease obligations) ratio of 2.7 times (x). The ratings also consider CVS's strong positioning in all prescription distribution channels, with a #2 market position in the retail segment and pharmacy benefit management (PBM) and a #1 position in the fast-growing specialty pharmacy business, making it the largest provider of prescriptions in the U.S. with a 20% share of 2010 prescription volume.
The company is well positioned to drive continued market share gains and capitalize on favorable industry trends for prescription growth such as the aging population and expansion of coverage to the uninsured, the continued growth in higher-margin generics and mid-teens growth in specialty pharmacy over the next five years. Of concern are the ongoing cyclical pressures on the industry, the industry-wide pressure
on pharmacy pricing and reimbursement rates in both the retail and PBM businesses, and any potential hit to profitability from regulatory issues.
Retail EBIT growth expected to be in the 7 - 9% range between 2011 - 2013
The retail segment which accounts for approximately 70% of operating profit continues to perform well in spite of near-term cyclical pressures and the company continues to lead the drug retail sector in sales productivity and other operating metrics. It has had a successful track record in integrating large-scale retail acquisitions over the past 10 years, while maintaining a healthy level of growth and improving profitability on an organic basis.
As large-scale retail acquisition opportunities are limited going forward, share gains will depend on: generating above-average organic growth; store closings or share losses by weaker independents and regional chains; and small market fill-in acquisitions and prescription file buys. Fitch expects retail top-line growth to be in the 3 - 4% range going forward with comparable store sales growth in the 2% range and square footage contribution in the 1.0 - 1.5% range. Operating profit growth is expected to be 8% in 2011 and 7 - 9% in 2012 - 2013, with continued pharmacy pricing and reimbursement pressures offset by a robust generic pipeline, continued improvement at acquired units, and expense leverage on higher volume. Retail EBIT margin are expected to increase by 30 - 40 bps annually over the next two years on an expected base of 8.2% in 2011.
PBM business operating profit margin expected to expand in 2012 after three years of decline
CVS has seen positive momentum in its PBM segment in 2011 from a top line perspective with strong business wins that will continue to be accretive in 2012. Top line is expected to grow in the high teens range in 2012, after an expected 25% growth in 2011. The 2012 expectation reflects net new business wins through the third quarter of $4.8 billion and PBM contracts associated with the UAM acquisition which is expected to contribute $5.5 billion in incremental revenue in 2012.
The company should finally be able to realize margin expansion in 2012 and beyond in this business segment from a 2011 expected level of 3.8% as the company integrates large scale contracts such as Aetna Inc. The company should also begin to realize benefits from the streamlining initiatives that it put in place late last year to deliver over $1 billion in cost savings from 2011-2015, with benefits outweighing costs in 2012.
Overall EBIT growth expected to be in the low to mid-teens for 2012
Fitch expects total EBIT growth including retail to be in the low to mid-teens for 2012, after a relatively flat 2011. CVS continues to generate strong free cash flow providing the company with strong financial flexibility. Fitch expects $3.0 in annual free cash flow (after dividends and before any sales leaseback transactions) over the next few years. Fitch expects excess cash flow after capital expenditures will primarily be used toward increased dividends, share buybacks, and any bolt-on acquisitions within the context of maintaining adjusted debt/EBITDA at 2.7x. The company has no debt maturities in 2012-2013, with the next maturity of $550 million in 2014.
There are several issues to monitor in the drug store sector over the next couple of years. First, the generic pipeline will start building up in 2012. This would be positive for pharmacy gross margins and could provide an upside to Fitch's estimates. Second, the potential merger of Express Scripts, Inc. (Express Scripts) and Medco Health Solutions Inc. could put pressure on retail pharmacy reimbursement rates. Third, there is a potential benefit to CVS and Rite Aid if Walgreen Co. does not renew its contract with Express Scripts, due to expire at the end of this year. Fourth, ongoing healthcare reform initiatives could pressure reimbursement rates but be positive for prescription volume over the intermediate term if a prescription plan is put in place for the uninsured.
Fitch has affirmed the following ratings:
--Long-Term Issuer Default Rating (IDR) at 'BBB+';
--Senior unsecured bank facility at 'BBB+';
--Senior unsecured notes at 'BBB+';
--Short-Term IDR at 'F2';
--Commercial paper at 'F2'.
Fitch expects to withdraw its ratings on the $1.0 billion ECAPS hybrid security current rated 'BBB-' at the successful completion of the tender offer which the company announced on November 29.
Additional information is available at ' www.fitchratings.com '. The ratings above were unsolicited and have been provided by Fitch as a service to investors. The issuer did not participate in the rating process other than through the medium of its public disclosure.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 12, 2011);
--'Short-Term Ratings Criteria for Non-Financial Corporates' (Aug. 12, 2011).
Applicable Criteria and Related Research:
Corporate Rating Methodology
Short-Term Ratings Criteria for Non-Financial Corporate