Health Outlook for CVS Caremark

01/28/2014 7:00 am EST

Focus: STOCKS

Richard Moroney

Editor, Dow Theory Forecasts

Increased use of generic drugs, along with the rising number of individuals with health insurance, are boosting the long-term prospects for our latest featured stock, a leader in the drugstore and pharmacy benefits sector, notes Richard Moroney, editor of Dow Theory Forecasts.

CVS Caremark (CVS) shares have soared in the past three months, handing investors a 23% total return, compared to an average of 8% for S&P 500 Index (SPX) consumer-staples stocks.

Analyst earnings estimates have risen since CVS gave its 2014 outlook last month, which implies per-share-profit growth of 10% to 14%. Recent sales gains have been fairly evenly split between the pharmacy-benefit manager (PBM) and drugstore chain.

Wider use of generic drugs—cheaper in price than their branded counterparts, and more profitable for CVS—has helped fatten profit margins.

CVS' pharmacy-benefit manager has exposure to insurance exchanges in 25 states, accounting for almost 70% of the eligible exchange population. PBM growth should contribute to higher foot traffic at CVS retail pharmacies.

The PBM should benefit from expanded coverage offered by the Affordable Care Act, with management expecting 30 million Americans to gain health insurance by 2018.

Other catalysts could help drive long-term growth. Through a venture with Cardinal Health (CAH), CVS will receive a $25 million payment each quarter and gain substantial purchasing power with generic drugs.

A planned $2.1 billion acquisition will push CVS into the high growth area of home infusions. CVS expects per-share profits to climb 10% to 14% annually, over the next five years.

Share repurchases should also contribute to the higher per-share profits, with management announcing a fresh $6 billion share-buyback program in December. CVS has lowered its share count 4% in the past year, and by nearly 9% over the last two years.

CVS has raised its dividend, at least 20% in four consecutive years, the most recent, a 22% boost in December. Management expects to return to investors 35% of earnings through dividends by 2018, versus the current payout ratio of about 24%.

To reach that level, CVS estimates it will have to grow the dividend at an annual rate of 18%. Overall, a reasonable valuation, favorable outlook, and strong track record earn CVS a Long-Term Buy rating.

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