CVS Turns in Strong Third Quarter, Boosts 2019 Outlook

Narrow-moat CVS Health CVS turned in third-quarter operating results that beat Capital IQ consensus on the top and bottom lines. With those strong trends, management raised some metrics of its 2019 outlook slightly, although its cash flow guidance did not change. Overall, we continue to view CVS' shares as undervalued. We see compelling cross-selling opportunities and other synergies as the organization integrates the Aetna insurance operations with its legacy retail store and pharmacy benefit management businesses.

In the quarter, revenue reached $64.8 billion, above consensus of $63.0 billion, and adjusted earnings per share grew 6% to $1.84, above consensus of $1.77. While about $0.04 of that is related to a capital gain and positive prior-year development, the company's underlying businesses performed well, too. Management raised adjusted EPS guidance to $6.97-$7.05 from $6.89-$7.00. However, its guidance for operating cash flows ($10.1 billion-$10.6 billion) and capital expenditures ($2.3 billion-$2.6 billion), which is the primary driver of our fair value estimate, did not change.

By segment, CVS' PBM business delivered strong 9% growth in claims processed to 510 million in the quarter on an adjusted basis, but adjusted operating income grew only 6% to $1.4 billion due to ongoing price compression. The retail/long-term care segment grew 3% year over year to $21.5 billion in sales, but adjusted operating income declined 7% to $1.5 billion in the quarter due primarily to reimbursement pressure. Positively, though, the retail store operations remained strong with an 8% increase in prescription volume and a 110-basis-point increase in prescription share in the United States to 26.6%. In the legacy Aetna operations, the company generated $17 billion in sales and adjusted operating income of $1.4 billion, which management highlighted as beating internal expectations.

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