CVS - CVS Health Corporation

[KCLarkin]

I have followed and owned CVS for years but I am quickly becoming a fan of the man that runs WBA.

 

CVS is a cigar butt investment for me. But WBA is very intriguing too. Pessina is 74. Not as old as Buffett or John Malone but not ideal for a jockey bet.

[DooDiligence]

Good points KC. 

 

I have been hearing from some industry people that payors and by extension their PBMs may be pushing pharmacies to turn increasingly to the old fee-for-service revenue model rather than the prevailing mark up model.  The current structure is a mix between fee-for-service and a mark-up from the perspective of the pharmacy. 

 

CVS in their most recent Q discloses this trend in a muddled way but it is there.  Payors/PBMs are after the spread the retailers earn on the drugs dispensed, especially on generic, which if this catches steam it could be a big challenge for CVS & WBA. 

 

 

As MCOs & PBMs have scaled, in the face of runaway growth in drug spend, they are increasingly searching for innovative ways to minimize spend.  We all know about the rise in mail prescription fills that has been successful in recent years.  ESRX is now filling 28% of all scrips by mail.  This bypasses the pharmacy channel and lowers overall costs in the transaction chain for payors and consumers .  Curiously, CVS's Caremark, only fills 18% of its scrips through the mail despite rivaling ESRX in scale. 

 

There is also the movement to the "90 day" fill but of course even though it is good for Caremark is is bad for CVS retail as it reduces foot traffic that is critical to support the "front store" retail.  The inherent conflict of interests are growing and their counterparts including competitors and customers know this.

 

Given the scaled customer concentration and bargaining advantage this delivers, WBA may realize that it is futile to resist this trend and is proactively ceding margin to secure exclusive access to these networks which will provide guaranteed traffic levels to its front store operations.  In other words, being a first mover hoping to reap the benefits while CVS is tied up trying to figure out how they can optimize the relationship between their PBM & retail operations to better appease customers.  I do not expect Caremark  to lobby on behalf of clients to follow the emerging trend as it may prove catastrophic for the CVS retail side.  I am aware of the ABC/WBA tieup and this will not happen over night night but it is important to note that ABC is the largest specialty distributor in the game and the supply chain operates largely outside the traditional channels. 

 

I haven't even touched specialty which we can leave for the next post but there is one more thing worth mentioning.

 

There is increasing activity by payors/PBMs to buy direct from producers.  This has the potential to disrupt the wholesaler business as they are forced to accept another fee-for-service arrangement.  Put simply, the PBM will buy the drug from Pfizer pay CAH to deliver it to the pharmacy where the pBM will pay the pharmacy a dispensing fee for the service. 

 

This is not mumbo jumbo as I have heard as much from some of the big players in the ecosystem and they are all trying to protect their profit pool but it is hard when you are up against the Goliaths of the world and battling on a sinking ships of sorts. 

 

MCK went through this transition in the mid 2000's (on its own volition) after a period flat to falling drug prices causing losses on inventory balances held.  At the time, they decided to shift to a fee-for-service model that while deliver lower overall margins required much less capital investment ultimately driving higher overall capital returns. Unfortunately, CVS has a ball & chain in the way of its brick & mortar retail business and so may not be as flexible as MCK was at the time. 

 

Btw, the Citi Analyst predicted much of this conundrum back in 2014 as detailed in the WBA initiation report.  Great primer on the retail sector.  I will post it if anyone's interested. 

 

Bonus read for those that want a helpful primer on pharma supply chain [url=http://[url=http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf][url=http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf]http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf][url=http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf]http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf]http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf][url=http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf]http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf]http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf]http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf][url=http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf]http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf]http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf]http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf]http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf][url=http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf]http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf]http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf]http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf]http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf]http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf]http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf]http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf]http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf]http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf]http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf]http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf]http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf]http://www.americanhealthpolicy.org/Content/documents/resources/December%202015_AHPI%20Study_Understanding_the_Pharma_Black_Box.pdf

 

Thanks for the link & the commentary.

 

Before I read this, I didn't really understand enough about PBM's & the other industry players/payers to confidently choose a company to invest in.

 

After reading, I understand well enough to know that there's too many moving parts (I'll stick to the upstream end...)

 

Pharma manufacturers fortunes may wax & wane but survivability seems more assured.

[DooDiligence]

CVS is no longer part of the Blue Cross Blue Shield preferred pharmacy network.

 

CVS will continue to accept Blue Cross Blue Shield Medicare Part D plans.

 

CVS says any customer who still has questions should bring their prescription card to their CVS for assistance.

[ABM]

Since my last post, I have learned that CVS is the largest plan provider/sponsor for LIS Medicare Part D enrollees.  These represent 30% of Part D members but about 66% of total Part D spending.  ESRX has a neglible level of Part D members as a plan sponsor. 

 

This is what the companies refer to as "direct" or when they are not acting as only the PBM.  They are taking some insurance risk on the revenue. 

 

I raise this point b/c it is becoming clear that the incentive structure for Part D, in its current form, benefits the MCOs/PBMs at the expense of Medicare and the individuals.  The increasing levels of rebates protect profits while simultaneously shifting more of the ultimate drug cost to the individuals and Medicare. 

 

It is complicated to explain the nuances but you can see Medpac report from June 2015 for more details. See link http://www.medpac.gov/-documents-/reports

 

Excerpt from 2015 Medpac report

"One commenter pointed out that the rebates sponsors receive from manufacturers for all brand-name drugs dispensed to enrollees who reach Part D’s catastrophic threshold (including rebates in the coverage gap phase) can more than offset plans’ 15 percent share of payments for spending that exceeds the Part D catastrophic threshold. Thus, requiring plans to pay a share larger than 15 percent could provide greater incentive for sponsors to negotiate larger rebates with manufacturers or design formularies in ways that encourage greater use of lower cost drugs."

 

As Part D spends $73B/yr or ~25% of total US net drug spend using tax payer funds, I can see how any shenanigans by the suppliers (e.g. PBM/MCOs) will be leveraged and politicized by opponents to the existing model. 

 

There is no question that drug companies are raising gross/list prices to offset the higher rebates they must provide network customers (e.g. PBMs).  This allows them to recapture some revenue at the point-of-sale (e.g. retail pharmacy) from the individual as their co-payment/coinsurance is calculated based on the list price and not the net price received by the PBM/MCO.  Further compounding the matter is the shift to higher deductible plans in the commercial market that is forcing individuals to absorb more of this "gross pricing" increases at point-of-sale. 

 

This is how yesterday's WSJ report cites insulin shots costing Joe from wherever $400 last month and $600 this month in out-of-pocket expense at the pharmacy while at the same time PBMs are promoting drug inflation for their clients tracking the 3% level in 2016.  It is because the PBM only consider the plan spend by their customers and not total drug (which includes what the individuals pay out of pocket). 

 

Excerpt from Jan 2017 JPM Healthcare Conference

ESRX CEO

"Quite frankly, there is no question in my mind that the reason that our clients today have a 3.9% drug trend is because we exist and we have created that competition in classes where there are multiple agents that could take care of a patient and I'm not going to apologize for that and I know our industry is not going to apologize for that."

 

Excerpt from CVS investor day Dec 2016

CVS CEO

"One of the hallmarks of this value proposition, it lies in our ability to help clients more effectively manage their pharmacy spend, and we continue to deliver on this goal with our clients realizing only a 3.3% increase in their pharmacy spend through September of this year."

 

 

[ABM]

Lawsuit filed today against Lilly, Sanofi, and Novo for price collusion on insulin drugs and surprises they name PBM as accessories to the conspiracy but they are not defendants name in the lawsuit.  Worth the read for background on supply chain

 

https://static01.nyt.com/science/01-30-17_Insulin_Class_Action_Complaint_Hagens_Berman.PDF

[DooDiligence]

Lawsuit filed today against Lilly, Sanofi, and Novo for price collusion on insulin drugs and surprises they name PBM as accessories to the conspiracy but they are not defendants name in the lawsuit.  Worth the read for background on supply chain

 

https://static01.nyt.com/science/01-30-17_Insulin_Class_Action_Complaint_Hagens_Berman.PDF

 

I'll be interested in the plaintiff's responses.

 

Wonder why the PBM's weren't named as plaintiff's?

[KCLarkin]

Anyone have a copy of the Baird report downgrading CVS that they can share?

 

 

[fareastwarriors]

Anyone have a copy of the Baird report downgrading CVS that they can share?

 

Here you go. Please post your thoughts after you go through it. Thanks.

RobertWBairdCo_DowngradetoNeutralOurCanaryLooksIll_Feb_01_2017.pdf

[xtreeq]

This is great, thanks

[KCLarkin]

Here you go. Please post your thoughts after you go through it. Thanks.

 

First, kudos to the analyst for taking such a strong stand. I wish more analysts had backbone.

Second, analyst had an overweight/$114 target in April. Most of the change is due to lowering his terminal PE multiple from 15x to 10x. Sentiment has clearly soured.

Third, his model forecasts annualized 7% EPS growth over the next 5 years. So how does he justify current P/FCF of only 12x? He assumes PE multiple contraction to 10x by 2021. Oddly, he also ignores dividends in his FY21 P/E analysis, so I think his PT is an error.

 

In other words, he is fitting his valuation to his sentiment. Standard practice.

 

--

The key question he raises: what risk does DIR controversy pose to future FCF?

 

First, what is the likelihood that Congress, Executive, Courts, CMS, or market forces reign in DIR?

Second, even if this does occur, will it be material?

Third, even if it is material, will a positive surprise (e.g. corporate tax cuts) balance out negative surprises?

 

The answers to all of those questions seem unknowable. Clearly, sentiment against PBMs is very strong right now. But that has been true throughout history. But then again, with the current administration literally anything could happen. Including Trump expropriating CVS and turning it into a  chain of for-profit prisons.

 

Is the DIR narrative just a reflection of the current negative sentiment on PBMs? On a more optimistic day, I could argue that the excessive DIRs are a reflection of CVSs moat and market power.

 

--

 

How do we resolve this? I like Howard Marks framework -- we can't know where we are going but we can know where we stand. So where do we stand? There is clearly a sense of uncertainty and doom surrounding CVS. Seems like a good time to buy a wonderful, recession resistant business.

 

 

[KCLarkin]

Here is CVS' statement on DIR fees:

http://investors.cvshealth.com/~/media/Files/C/CVS-IR-v3/reports/CVS%20Statement%20on%20DIR.pdf

 

And here is a whitepaper arguing the other side (note this is paid for by CVS opponents):

https://www.communityoncology.org/wp-content/uploads/2017/01/COA_White_Paper_on_DIR-Final.pdf

 

 

[DooDiligence]

Here is CVS' statement on DIR fees:

http://investors.cvshealth.com/~/media/Files/C/CVS-IR-v3/reports/CVS%20Statement%20on%20DIR.pdf

 

And here is a whitepaper arguing the other side (note this is paid for by CVS opponents):

https://www.communityoncology.org/wp-content/uploads/2017/01/COA_White_Paper_on_DIR-Final.pdf

 

Great find (I Googled like crazy trying to get that Frier Levitt paper!)

[John Hjorth]

Thanks for sharing your findings here, KCLarkin, i's much appreciated.

 

I have duly noted your comments about the origin of the Frier Lewit report. I have read the executive summary only so far, but I will read the report in full later, but soon.

 

Are the health care schemes involving public funds subject to audit?

 

The whole system, with the PBM's handling enormous amounts dollars, seems to me to be totally screwed by discounts, rebates and the likes, - to an extent, so that a price is no longer just a price.

 

I'm not trying to derail this topic a part from CVS, but I have attached a screen shot from the NVO 2015 Annual Report, containing gross-to-net sales reconciliations 2013 - 2015 [p. 64]. NVO is a mini in the pharma industry. The discounts etc. seems to me like cartoon figures.

 

- - - o 0 o - - -

 

Here, if a report like the Frier Lewitt report popped up in public, the Danish IRS would test the allegations separately on own initiative or on request, and in the end hand out a control report to whoever wanted to read it. If any material problems, somebody would be in real trouble.

[KCLarkin]

I have duly noted your comments about the origin of the Frier Lewit report. I have read the executive summary only so far, but I will read the report in full later, but soon.

 

If you read it, remember that it is written by lobbyists on one side. The PBM/Plan sponsors are lobbying form the other side. In other words, it is like reading only the plaintiffs legal brief.

 

It is clear that the US medical system creates some perverse behaviour and skewed incentives. But I didn't see anything egregious in the report. I'm not sure why the Baird analyst reacted so harshly.

[DooDiligence]

I have duly noted your comments about the origin of the Frier Lewit report. I have read the executive summary only so far, but I will read the report in full later, but soon.

 

If you read it, remember that it is written by lobbyists on one side. The PBM/Plan sponsors are lobbying form the other side. In other words, it is like reading only the plaintiffs legal brief.

 

It is clear that the US medical system creates some perverse behaviour and skewed incentives. But I didn't see anything egregious in the report. I'm not sure why the Baird analyst reacted so harshly.

 

Thanks for pointing that out.

 

My stake in Novo Nordisk & biotech ETF's has me biased towards where the blame should go.

 

I still believe that pharma manufacturers have better long term prospects than the downstream entities.

[KCLarkin]

The whole system, with the PBM's handling enormous amounts dollars, seems to me to be totally screwed by discounts, rebates and the likes, - to an extent, so that a price is no longer just a price.

 

The pharma companies are trying to deflect pricing scrutiny to the PBMs. There seems to be a growing consensus that PBMs are leaching excessive profits out of the system. But a quick sanity check shows this isn't true.

 

The entire CVS company, including the retail pharmacy, front-of-store sales, health clinics, PBM, and insurance operations only generated Net Income of $5.2 B in 2015. That's about 1% of US drug spending.

 

PBMs are not the cause of the price increases. PBMs are using their buying power to demand lower prices. Rather than sacrificing profits, the drug companies are jacking up list prices. It is remarkable how effectively the drug companies have scapegoated the PBMs.

[John Hjorth]

Thanks for your input here, KCLarkin,

 

I try to stay open minded about the whole US healtcare system as it is right now, because I do not have enough knowledge about it to make a judgement.

 

I will take a look at the four major PBMs in the weeks to come.

 

My post about the rebates, discounts etc. was meant to be read so to say straight out.

[gjangal]

The industry seems to be moving to a place where the PBM function is facing revenue pressure by either being folded into the payers ( Blue shield and prime therapeutics) or with the pharmacy ( CVS Caremark) . The drug wholesalers ( MCK, CAH, ABC) also have to rethink their model. Their revenues are under pressure with pharmacy players consolidating, drug warehousing also is becoming a part of the pharmacy function increasingly ( WBA and ABC)

 

WBA has made nice moves in this market compared to CVS. They moved to buy Rite aid, struck a deal with prime therapeutics for pharmacy benefits and bought stake in ABC to control warehousing. CVS also has a deal setup with CAH for generics.

 

Anthem's renewal with Express scripts ( around 14 mm members) may be in question as renewal come up. They might choose to go with prime therapeutics which is co-owned by all the bcbs plans. WBA stands to gain if they do this.

[KCLarkin]

Here is an example of the absurd scapegoating that Big Pharma is doing:

https://www.bloomberg.com/news/articles/2017-02-08/seeing-danger-of-trump-s-new-thing-health-group-preps-defense

 

The top executive at British drug giant GlaxoSmithKline Plc took a veiled swipe at the PBM industry on Wednesday, citing an industry-sponsored report that out of every $100 of a drug’s list price, only two-thirds ends up back with the drugmaker.

 

Much of the rest goes to “non-innovators in a system which thinks it’s paying high prices for innovation,”

 

--

Bob is shopping in a Mexican street market. He spots a beautiful pottery piggy bank. He decides to buy it for his son. "How much?" he asks. "1000 pesos," replies the seller. Bob walks away.

 

A little while later, he is drinking a Cerveza with his friend Pablo B Morales. He tells Pablo about the beautiful piggy bank. Pablo replies, "You need to haggle harder. Do you want me to go speak to the seller?".

 

Pablo goes back to the seller and haggles down the price to 500 pesos. Bob gives Pablo 50 pesos in gratitude.

 

Bob returns the next year. The seller is now selling piggy banks for 1500 pesos.  And tourists are complaining about the high price of piggy banks. The clever seller says, "you must understand. Only 1/2 of the list price ends up in my pocket. Much of the rest goes to non-innovators in the system."

 

--

List Price: 1000

Net Price: 500

P.B.M: 50

 

Who are the "non-innovators" who took the remaining 450 pesos?

[giofranchi]

Strong Q4 2016 results:

http://seekingalpha.com/news/3241986-cvs-q4-revenues-12-percent-earnings-14-percent-shares-2-percent-premarket

 

Selling for little more than 13x forward earnings, while still growing sales and earnings at a very healthy rate, CVS looks very interesting.

 

Can someone sum up the bear thesis?

 

Cheers,

 

Gio

[DooDiligence]

Here is an example of the absurd scapegoating that Big Pharma is doing:

https://www.bloomberg.com/news/articles/2017-02-08/seeing-danger-of-trump-s-new-thing-health-group-preps-defense

 

"As part of PBMs’ lobbying plan, they list $100 billion in government savings that could be proposed to Trump and Congress as a way to get drug costs down -- and deeply cut drug and biotech profits. That includes shortening the time during which drugmakers have exclusive sales rights on new treatments and raising taxes on the industry."

 

 

Anyone know what time frame the proposed $100B savings would extend over?

 

What this lobby calls "exclusive sales rights" are patents & they're there to allow pharma manufacturers who've spent $2B+ over a decade or more (not counting the $ on discontinued/failed projects) to actually recoup & turn a profit.

 

On that note; I submit that they should add an extra year to the "period of exclusivity" in exchange for lower gross margin introductions of branded products & price increases capped to inflation (admittedly difficult to legislate & monitor) & a requirement that the branded producer introduce a generic version 2 years before patent expiration to further allow them to earn a ROIC while lowering drug spend.

 

The industry should probably get proactive now, on the introduction of generics to its own products.

 

The last point I raise (in my carefully cherry picked paragraph from the article ) is in regards to the lobby's suggestion that taxes would be a solution (taxes, really?)

 

Express Scripts shows an 8.x% GM & 4.x% OM which doesn't seem egregious.

 

Pharmas post significantly higher GM's & OM's.

 

Who's taking the biggest risks with owners capital?

 

I'm OK with Novo Nordisk dropping prices to remain competitive but how much is enough?

 

How about some transparency in the rebates (a breakdown on every sales receipt showing list & net prices along with how much of the difference is charged to the patient IN BOLD.)

 

Heyyyyyy wait a minute - this administration campaigned against regulations.....

[DooDiligence]

http://finance.yahoo.com/news/elephant-courtroom-federal-judge-said-141429369.html

 

I await the presidents Tweet with baited breath!

 

 

[KCLarkin]

More lobbying in the DIR battle:

https://naosp.wildapricot.org/resources/Pictures/NASP%20Response%20to%20PCMA%20Comments%20Regarding%20DIR%20Fees.pdf

 

But this seems to undermine their argument:

 

There is no cap on the dollar figure of the percentage fee applied in some DIR Fee programs, resulting in upwards to $1,000 per prescription being pulled back from the specialty pharmacy.

 

In other words, specialty pharmacies were earning up to $1000 per prescription just from the spread. No wonder the payors are trying to claw this back. And no wonder the pharmacies are fighting so hard to rein in the PBMs.

 

Basically, specialty pharmacies are charging medicare part D plans up to $1000 per prescription for expensive drugs. What a scam.

 

--

In other news, the nominee for CMS nominee seems to side with the PBMs:

 

In other words, she is unlikely to press for medicare to negotiate drug prices directly.

[KCLarkin]

This program looks pretty interesting:

https://www.reducedrx.com

 

If this expands to other drugs, it would help fix many of the issues with gross versus net pricing.

[Jurgis]

This program looks pretty interesting:

https://www.reducedrx.com

 

If this expands to other drugs, it would help fix many of the issues with gross versus net pricing.

 

I've seen similar (?) drug benefit cards in junk mailer coupon packs in the past. Not sure what was covered, who was paying for the discounts, etc. Never dug deeper.