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CVS Health Corporation's PBM Strong, but Retail Business Weak in 2nd Quarter

CVS Health (NYSE: CVS) didn't disappoint the last time the pharmacy giant announced its quarterly results. The company's profit was down in the first quarter, but still beat expectations. Still, CVS Health has referred to 2017 as "a rebuilding year."

The company announced its second-quarter results before the market opened on Tuesday. Did CVS Health take another positive step in its rebuilding effort? Here are the highlights from the company's second-quarter update.

Image source: Getty Images.

CVS Health results: The raw numbers

Metric 

Q2 2017 

Q2 2016 

Year-Over-Year Change

Sales

 $45.7 billion  $43.7 billion

4.5%

Net income from continuing operations

 $1.1 billion  $924 million

18.8%

Adjusted EPS

 $1.33  $1.32

0.8%

Data Source: CVS Health. EPS = earnings eps share.

What happened with CVS Health this quarter?

There was good news and bad news for CVS Health's top line. The good news was that revenue for its pharmacy-services segment, which provides pharmacy benefits-management (PBM) services to customers, increased 9.5% year over year, to $32.3 billion. This growth stemmed from higher pharmacy-claim volume, higher brand-drug prices, and increased specialty drug volume.

What was the bad news? Revenue for the retail/long-term care (LTC) segment slipped 2.8% year over year, to $19.6 billion. Three key factors contributed to this decline: a 2.6% decrease in same-store sales, a higher generic dispensing rate, and continued reimbursement pressure. 

That decline in same-store sales was the result of a drop in both pharmacy and front-store same-store sales. Pharmacy same-store sales fell primarily because of the recent introduction of new generic drugs, which have lower prices than brand drugs. Front-store same-store sales dropped due largely to softer customer traffic, despite a positive impact from the Easter holiday falling in the second quarter instead of the first quarter as it did last year.

CVS Health's net income was significantly higher than the prior-year period on a GAAP basis. However, the improvement was mainly due to the impact of a $542 million loss on early extinguishment of debt in the second quarter of 2016.

The company opened 27 new retail locations during the second quarter and closed three retail locations. CVS Health also relocated 10 retail locations. As of Jun. 30, 2017, the company operated 9,700 retail locations in 49 states, the District of Columbia, Puerto Rico and Brazil.

What management had to say

CVS Health CEO Larry Merlo said:

The second-quarter results we posted today keep us nicely on pace to achieve our full-year targets. Operating profit in the retail/LTC segment was in line with expectations while operating profit in the pharmacy services segment exceeded expectations. At the same time, we have generated substantial free cash flow year-to-date and continued to return significant value to our shareholders through dividends and share repurchases. While we are pleased to report results consistent with our expectations, we won't be satisfied until the total enterprise returns to healthy levels of earnings growth."

Looking forward

CVS Health now expects full-year GAAP diluted earnings per share guidance between $4.92 and $5.02. The company previously provided full-year guidance of $5.02 to $5.18. Full-year adjusted earnings per share are expected to be between $5.83 and $5.93, narrowed from the previous guidance of $5.77 to $5.93. CVS Health also maintained its full-year guidance of cash flow from operations of $7.7 billion to $8.6 billion and free cash flow of $6 billion to $6.4 billion.

In the third quarter, CVS Health projects GAAP diluted earnings per share between $1.20 and $1.23, with adjusted earnings per share between $1.47 and $1.50. All of these estimates include the assumption that the company will buy back $5 billion of its stock.

The company's full-year guidance underscores just how much of a rebuilding year 2017 actually is. CVS Health's projections call for, at best, only slight improvement in adjusted earnings per share from 2016 to 2017. Net revenue is expected to grow by only 3% to 4%.

A big factor in the anemic earnings growth is that CVS Health is getting more sale growth from its pharmacy-services segment, but that business isn't as profitable as its retail/LTC segment. This dynamic isn't likely to change anytime soon.

However, CVS Health continues to generate very strong cash flow. And it continues to reward investors through dividends and share repurchases. Despite current challenges, CVS Health's business model still appears to be solid.

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Keith Speights has no position in any stocks mentioned. The Motley Fool recommends CVS Health. The Motley Fool has a disclosure policy.