Highlights

Growth in Medicare Lives: With 10,000 baby boomers

turning 65 every day, the Medicare-eligible population is
increasing. CVS is well positioned to serve this market
through their retail pharmacies, PBM, and SilverScript which is
Marketcurrently
Profile in second place for Medicare Part D prescription
FINPrice
4310-001
Company
Valuation
drug plan. CVS
has reported
more than 24,000 pharmacists
52 Week
Range
72.37-105.46
04/08/2015
across their enterprise.
Average Daily Volume
4,600,250
Reduce Costs Not
Care: With U.S. health care and
prescription drug spending on the rise, CVS offers
Beta
0.96
comprehensive solutions that help clients manage this trend
wthout sacrificing
patient care. With one large health plan
Dividend Yield (Estimated)
1.40(1.30%)
client, CVS entire enterprise is involved and collaborating
Shares Outstanding
1.14B medical home (PCMH) model. CVS
with its patient-centered
provides
face-to
face
adherence counseling while also
Market Capitalization
117.09B
providing information directly into the patients electronic
Institutional Holdings
87%
health record at the PCMH.

Insider Holdings
Book Value per Share
Debt to Total Capital
Return on Equity

120.00

100.00
80.00
60.00

New Ways to Save:

CVS Health is pioneering new strategies
2.04M
to lower costs for health plans and their members, which
33.3 utilization and innovative formulary
includes CVS/minuteclinic
strategies. CVS is also
participating in narrow restricted
34.13
pharmacy networks. CVS reduced co-pay at CVS/minuteclinic
12%who use their walk-in medical clinics. Also,
by 8% for patients
formulary management strategy is expected to drive total
incremental client savings of 3.5 billion from 2012-2015.
Removing Tobacco Products: CVS is the first national
pharmacy chain to remove tobacco products from shelves. It
is reported that once you quit smoking, it only takes 20
minutes for the body to begin healing. CVS has proven that
they are not solely focused on driving sales and revenues, but
in the overall health of its clients.
(Source 1)

40.00
20.00
0.00

Historical EPS
Q2

Q3

Q4

Year

2012
$0.60
Stock Info
2013 $0.77

Q1

$0.76
$0.92

$0.80
$1.03

$0.90
$1.06

$3.04
$3.77

2014

$1.06

$0.82

$1.16

Ticker

$0.96

$3.98

CVS

Current Price

103.65

Recommendation

HOLD

Price Target

98.43

TICKER: CVS

CVS Stock Price

Current Price:
$103.65

CVS Company Valuation

Group Members
Kouame Dadie
Pjoter Hasa
Josh Houser
Tim Price

CVS Company Valuation

Business Description
CVS Health Corporation, jointly with its affiliates, delivers incorporated pharmacy health
care in the United States. Through 7,700 retail pharmacies, more than 900 walk-in
medical clinics, a prominent pharmacy benefits administrator with more than 65 million
plan members, and escalating specialty pharmacy services, CVS facilitates individuals,
businesses and communities to administer well-being while being effective and also
making it affordable. CVS has an incomparable suite of competences and the capability
and proficiency needed to push innovations that will shape the future of health. For the
time being, CVS is the only incorporated pharmacy health care with the capability to
influence customers and suppliers with advanced, channel-agnostic solutions. CVS
programs are intended to encourage well-being, and to help direct unsuitable application
and non-obedience to medication, each of which has the possibility to result in
unfavorable medical events that undesirably impact affiliate health and client pharmacy
and medical spend. In response, CVS proposes different utilization management,
medication management, quality assurance, adherence and counseling programs to
complement the clients plan design and clinical strategies. (Source 2)
Primary and Secondary Markets/Products

CVS predominant clients are employers, insurance providing companies, mergers,

government employee groups health plans, Managed Medicaid plans and plans offered on
public and private exchanges other sponsors of health benefit plans and individuals
located throughout the United States. It offers pharmaceuticals to appropriate members in
benefit plans sustained by its clients and utilize its information systems, among other
things, to aid in performing safety checks, drug interaction screening and identify
opportunities for generic substitution. (Source 2)

Business Risks/Outstanding Litigation

In the year of 2011, according to the U.S. Justice Department, CVS pharmacies located in
Sanford, Florida, ordered excess amounts of painkillers, enough to supply a population
eight times its size. At the time, Sanfords population was a measly 53,000, however, the
order requested from CVS would be enough for a population of 400,000. According to
the Drug Enforcement Administration, it was recorded that in 2010, one CVS store
located in Sanford ordered a staggering 1.8 million Oxycodone pills, which averages
137,994 pills a month. When compared to its competitors, CVS average was more than
130,000 pills a month. According to the Drug Enforcement Administration, a pharmacist
working at a location in Sanford stated that, approximately every third car that came
through the drive-thru lane had prescriptions for oxycodone or hydrocodone. It was also
stated that customers requested drugs using street slang, which then was lead to believe
that the drugs were being misused, not solely for pain management purposes.
CVS recently experienced financial risk when they decided that they would no longer be
selling cigarettes. However, this was no easy decision since the sale of cigarettes
normally results in $2,000,000 in sales. Despite coming to the decision that cigarettes
would no longer be carried in CVS stores around the United States, the companys main
focus is to promote health and to secure a positive impact on the well-being of their
customers. (Source 3)

CVS Company Valuation

Business Model
CVS is a company most Americans are familiar with, primarily due to the fact that we are
reliant on their pharmaceutical products, and that they have a strong nationwide presence.
The company can be split up into three different segments:
Retail Pharmacy Segment:
CVS currently operates approximately 7,700 stores worldwide. This segment is made up
of three categories; Pharmacy, Front Store, and Minute Clinic. The Pharmacy fills
prescriptions and accounts for a significant amount of the companys revenue stream. The
Front Store category sells general merchandise as well as over the counter medications.
Lastly, the Minute Clinic allows customers to receive basic healthcare at their physical
locations, administered by registered professionals. CVS strategically places stores in
convenient locations, close to where people live or work. For this reason customers are
drawn to CVS not only for their pharmaceutical products, but also for groceries and other
consumer goods.
Pharmacy Services Segment:
This segment consists of their PBM business, Mail Order Pharmacy, Medicare Services,
and Specialty Pharmacy services. The bulk of annual revenue is attributable to this
segment. The PBM services consist of designing drug plans for other large entities,
managing benefits, and offering discounts through scale. The Mail Order business
accounts for all of their customers who prefer to receive their prescriptions through the
mail. The Medicare services part accounts for customers who are subscribed to the Part D
program, CVS distributes the benefit of that plan for those eligible customers. Lastly the
Specialty Pharmacy administers expensive medications for serious illnesses, such as
cancer or multiple sclerosis.
Corporate Segment
This segment provides support for the other two segments; including departments like;
Executive Management, Finance, Legal, Compliance, Human Resources, etc. (Source 1)

SWOT Analysis

Strengths

Low Cost Provider of Drugs

Limited Competition
Large Network of Locations
Loyalty Rewards Program
Large Brand Awareness

Weaknesses

Difficult to integrate acquisitions

High COGS and operational expenses

CVS Company Valuation

Opportunities

Change in healthcare laws

Aging population
Introduce more generic drugs
Global Expansion

Threats

Walmart focusing on pharmaceutical drugs

Changing Healthcare Environment
Generic drugs lowering margins
Revenue Drivers:
The bulk of the companys revenue comes from their Retail Pharmacy, and PBM
business. It is also important to note that their specialty drug products, for serious
illnesses, have exceptionally good margins, therefore CVS should focus on increasing
their specialty drug business.
Expense Drivers:
CVS does have a high Cost of Goods Sold, relative to Sales. The majority of their
expenses stem from COGS, discounts payable, accounts payable, and discounts and
claims payable.

(Source 2)
Gross Margin Trend:
CVS does not have the most impressive Gross Margins when compared to its fellow
Pharmaceutical competitors. Another worrying issue for management to consider is the
fact that over the past 5 years the gross margin has been trending down, indicating as the
companys revenues increase, margins decrease.

Recent Financial Performance

Recent Quarter:

CVS Company Valuation

Overall 2014 was a great year for CVS, but Q4 was an especially strong close to the year.
We would like to bring attention to the following key metrics, which give investors
promising feedback on the financial position of the company.

Adjusted earnings per a share (EPS): up 8.4% from last year Q4

Retail Operating Profit: up 6.5% from last year Q4
Returned more than $1.5 billion to shareholders in Q4
Repurchased more than 14.1 million shares for $1.2 billion in Q4
Consolidated Revenues were up 12.9% in Q4 vs. last year
Retail revenues up 2.9% vs last year Q4
Added 35 new clinics in Q4

These metrics reflect strong growth across all of CVSs operating segments, particularly
in retail. Strong performance was driven by strong pharmacy same store growth.
(Source 4)

Past Year (2014):

Overall 2014 was a very successful year for CVS.

Adjusted earnings per a share (EPS): up 13.5% from last year

Retail Operating Profit: up 7.9% from last year
Free Cash Flow: up 48.1% from 2013

CVS has been able to achieve significant growth in 2014, despite a controversial decision
to drop cigarettes from its stores, which had less of a negative impact than expected.
Past 5 Years:
The past 5 years have seen CVS experience significant growth, steadily
increasing its stores by 618, which equates to a 7.9% growth. With the
amount of stores increasing, revenues have also enjoyed a healthy
growth each year. In 2010 revenues were at $95 billion, but each year
they have grown, and last years revenues were up to $139 billion.
Another area that might excite investors is the companys dividend
over the past couple years, growing from $.35 in 2010, to $1.10 in
2014. It is important to note that in the past 5 years the greater
economy has seen significant growth as a whole, especially the stock
market. (Source 4)
Past 5 Years Income Statement:
The past five years have been very beneficial for CVS. They have seen
their revenues grow swiftly, but more importantly there profitability
steadily grow too. Earnings per a share have grown substantially from
$2.51 in 2010, to $3.98 in 2015.

CVS Company Valuation

Past 5 Years Balance Sheet:
As the company has grown steadily over the past few years, most
assets categories have imitated that steady increase. However there
are some notable increases. In 2013, Total Cash and Short Term
investments shot up from $1.3 billion to $4.2 billion, however they
experienced a rapid decline in 2014 back down to $2.5 billion.
Asset growth has been slow and steady, which is common of such a
mature large company. Notably, 2014 was the first year that the
company took on long-term investments in this period.
On the Liability side of the balance sheet there was similar steady
growth in liabilities. Total Current Liabilities saw a major increase,
driven by an increased reliance of short-term borrowings. Long-term
debt is actually down from 2013.
Past 5 Years Cash Flows:
Cash from Operations has seen a steady increase over the last few
years, experiencing a notable jump in 2014 from $5.7 billion to $8.1
billion. Cash from investing has also seen similar trends, rising from $1.1 billion to -$4.0 billion. Dividends paid are at a period high, and
they are paying back a large amount of debt. The net change in cash
flow has been fairly inconsistent, with no recognizable trends. (Source 4)

Peer Group Analysis

Our group narrowed down CVSs long list of competitors to the
following.

Walgreens:
A competitor with a very similar business model provides a good
benchmark due to their similarity.
United Health Group:
This is a competitor that possesses a very similar size profile, which is
emphasized by close market capitalization and revenue. While not a
direct competitor in the retail pharmacy arena, they are a fierce
competitor in the PBM segment.

CVS Company Valuation

Rite Aid Corporation:
While Rite Aid doesnt match CVSs size, they share a similar business
model. Rite Aid focuses on the Retail Pharmacy segment, as well as the
general merchandise products. (Groceries, Consumables, Beauty
Products, etc.)
Express Scripts:
This competitor provides a very good comparable due to the similarity
in size, and the similar business model of the PBM.
(Source 2)
Product Differentiation and Market share
CVS Health is subdivided into 3 segments as the largest integrated
pharmacy company in the United States. This includes CVS/Pharmacy
the second largest retail pharmacy in the country with more than 7,700
stores. CVS/Caremark its leading pharmacy benefit manager and mail
service pharmacy serving more than 60 million plan members.
CVS/Minute Clinic the retail health clinic system division of CVS Health,
the largest in the nation with more than 900 clinics locations.
CVS/specialty, the specialty pharmacy division of CVS Health, which
provides specialty pharmacy services for patients who require
treatment for rare or complex conditions.
In 2012, CVS Health filled 718 million prescriptions, which accounted
for 20% of the U.S. retail pharmacy market positioning the company as
the leader in the country. CVS products and services include: branded
prescription drugs, specialty prescription drugs, generic prescription
drugs over-the-counter nonprescription medication, cosmetics and
toiletries, Food and beverages, other merchandise and photo
processing services, personal health goods. (Source 5)

Porters Five Forces

The Drugstore Industry is a very large industry consisting of large, wellknown chains and small pharmacies that provide retail drug
prescriptions, over-the-counter medications, health and beauty
products, and often many other general merchandise (Groceries,
Beauty Products) product categories. The industry annual growth rate
is 2.2% with $257 billion in revenue. While local and regional
drugstores have their share of the market, the drugstore industry as a
whole is defined in large part by its heavy concentration. According to
"Drug Channels" in 2013 the pharmacy industry consisted of five major
chains which controlled 63 % of the industry revenues. These five
major chains included CVS Health, Walgreens Boots Alliance, Rite Aid
Corporation, Express Scripts and Walmart.
The demand for pharmaceuticals is constantly increasing as they
become more affordable to the average American due to health care.
The expansion of coverage, from laws such as the Affordable

CVS Company Valuation

Healthcare Act, will have a lasting positive impact on the demand for
drugs prescription and consequently on CVS Health future revenues.
Revenues of U.S. drugstores are expected to reach $350 billion by the
end of 2015, growing at 5.3% annually.
However, cost cutting
measures implemented by the government will likely shrink profit
margins. Despite potentially small profit margins, competition will
remain strong among industry players.
The Pharmacies and Drug Stores industry has moderate barriers to
entry, although barriers to entry are increasing. Due to industry
consolidation, which allows larger players to develop large networks
and
favorable
supply-side
contracts
with
pharmaceutical
manufacturers, the industry is expected to have more barriers to entry
over the next five years. Further offsetting potential industry entrants,
the industry is subject to federal and state laws that make retailing
certain products subject to stringent regulations. Nevertheless the
sector face increasing competition from general merchandise, food
retailers and supermarkets chains such as Walmart which has
infiltrated the list of the top five drugstore dispensers and gained
market share in the pharmacy business. Many regional and national
supermarket chains have significant pharmaceutical departments.
Since drugs store companies all elected to buy brand-name drugs via
a drug wholesaler rather than directly from a manufacturer they need
to contract with wholesalers. So there is some amount of supplier
power. Three drugs wholesalers companies control about 85% to 90%
of all revenues from drug distribution in the United States:
AmerisourceBergen Corp. (NYSE: ABC), Cardinal Health Inc. (NYSE:
CAH) and McKesson Corp. (NYSE: MCK). Cardinal services the CVS retail
stores and distribution centers, while McKesson supplies the Caremark
mail facilities and some small retail businesses.
(Sources 6,7,8)

Ratio Analysis
Our group decided to use a ratio analysis to better compare the peer
group of CVS. We focused on 4 major areas of comparison;
Profitability, Long Term Investment Activity, Short Term
Investment Activity, and Liquidity. Our purpose, after comparing
each firms relative ratios, is to better understand CVSs position in the
industry.

CVS Company Valuation

Profitability Ratios:

CVS Company Valuation

Profitability Ratios
As evidenced above, CVS has had a difficult time increasing its
profitability. When focusing on Gross Margin, it becomes clear that they
are trending down in this area. Their 5 year average for GM is 19.12%,
which ranks them 4th amongst the selected group of competitors.
It is a slightly better picture for the 3 other profitability ratios, all
showing signs of modest increases over the last 5 years. However,
when it comes to relative positioning, CVS is consistently ranking 4 th
amongst competitors. To our group, this is a sign of caution, because
they have been increasing revenues but at a decreasing rate of
profitability.
Long Term Investment Activity

Long Term Investment Activity Ratios

Overall CVS does have respectable turnover ratios; however their rank
amongst their competitors is not stellar. If you single out Walgreens vs.
CVS, CVS is at a slight disadvantage in the Total Asset Turnover, but
inches back with a higher Net Fixed Asset Turnover. Based on our
selected peer group, CVS does need to improve.

CVS Company Valuation

Short Term Investment Activity

Short Term Investment Activity Ratios

CVS has a Cash Conversion Cycle of 44.16, even though it is not the
highest amongst the peer group, it is a negative sign. The fact that it is
such a high number, and that it is positive, indicates that CVS may not
be using their working capital as efficiently as possible and that it may
have a problem turning cash spent on inventory into cash received on
products sold.
CVS has a healthy Inventory Turnover, ranking 2nd behind Express
Scripts, this shows that they are able to turnover inventory in an
efficient manner.
Short Term Investment Activity
-see following page.

CVS Company Valuation

Liquidity Ratios
CVS has a very strong Current Ratio, especially with respect to the peer
group; this highlights the fact that the company shouldnt have any
problems paying off its short term obligations. There is not too much
difference between the competitors when it comes to their Quick
Ratios; they are all within a small range of each other. It is promising
that CVS does rank 2nd in this category. CVS also holds the same
ranking when looking at the Cash Ratio. Overall, we consider CVS to be
the healthiest when it comes to liquidity; this is based off their strong
showing in all three of the above ratios.

CVS Company Valuation

Analysis of Future Performance

Our group has included a 5 year forecast, 2014-2019, of the project
Income Statement, Balance Sheet, and Statement of Cash Flows. The
financial statements can be found on the next page, preceded by a list
of our assumptions for the forecast.

Forecast Assumptions

CVS was at full operating capacity for 2014.

Assets must grow proportionally with sales.
Accounts Payable, Accruals, and Claims and Discounts Payable
will also grow proportionally with sales.
Assuming that Profit Margin is flexible.
Dividend Ratio will be maintained.
Holding all items that do not grow with sales constant.
All items that are infrequent, or rely on the firms decision at
that moment in time will also be held constant.
Assumption for growth rate:
o G1 = 7.83%
o G2 = 7.55%
o G3 = 7.43%
o G4 = 6.93%
o G5 = 6.50%
If AFN is negative, cash will be place into marketable
securities.
No new debt will be issued, unless AFN calls for it.
CVS will not find it ideal to issue any new stock.
Statement of cash flows will be generated using forecasted
financial statements exclusively, disregarding any adjustments
that CVS may have made in the current year.
Forecast will be completed using the percent of sales method.

CVS Company Valuation

Analysis of WACC
The weighted average cost of capital is a method of calculating
whether a company is earning a sufficient return to satisfy those
providing its capital, i.e. its creditors and investors. Each element is
weighted according to its proportionate share of the total capital. It is
the cost of debt, equity and other types of capital weighted according
to their relative contribution to total capital. (Source 9)
For the fiscal period ending December 31, 2014, CVS Health capital
structure was majority weighted with 75% total common equity and
25% total debt. The optimal capital structure would be the one that is
able to minimize the weighted average cost of capital; therefore,
increasing the intrinsic value of the stock. The expected stock return,
which is calculated by adding next years dividend yield to the dividend
growth rate, is 9.12%. The beta 0.96 is less than 1.00; therefore,
implying that the stock is less unstable than the market. With the beta
being less than 1.00, the investment has less risk. The CAPM model is
used to acquire the cost of equity, which is 9.12%. According to the
present capital structure, the weighted average cost of capital is
8.48%.
Our method for calculating the WACC of CVS:

CVS Company Valuation

CVS Company Valuation

Capital Structure
The current capital structure for CVS, based on WACC weights, is
approximately 90% equity and 10% debt. After looking at the other
competitors in their peer group, we feel that the current capital
structure is equal to the optimal capital structure.

CVS Company Valuation

Discounted Cash Flow Analysis

CVS Company Valuation

CVS Company Valuation

Discounted Cash Flow Analysis

CVS Company Valuation

Based on the above discounted cash flows, our findings show that CVS is fairly
priced, maybe slightly overvalued by a very marginal percentage. The current stock
price is approximately $101, which we believe fairly represents the PV of future
cash flows.
Assumption:
The terminal growth rate is 4.8%.

Dividend Discount Model Calculations

CVS Company Valuation

Using the dividend

discount model we
calculated that the
implied price is
$98.43, which is in
line with the implied
price calculated
using the DCF
method. This
essentially shows
that the current stock
price of CVS,
approximately $101,
is a fair price for the
future performance
of the stock.
Dividend Growth
Rate calculated using
the PRAT model.

CVS Company Valuation

Relative P/Es including PEGs

CVSs average P/E ratio for the last 5 years is 17.82, which means that investors
are paying $17.82 for every dollar that CVS earns. Their P/E ratio is on average
higher than most of their competitors, which implies that higher growth rate is
anticipated in the future for CVS when compared against its competitors.

CVSs PEG ratio seems fairly high at 2.3 compared to most of the other
competitors who had PEGs closer to 1.5. The PEG ratio for CVS was
calculated by dividing the current P/E ratio with the 2014 5YR average
EBITDA growth rate. A value above 1.00 generally indicates that the stock
price is overvalued. The PEG ratio shows that CVSs stock price is higher than
its intrinsic value, however based on our analysis we disagree.

CVS Company Valuation

Recommendation
Based on our analysis of the Discounted Cash Flows, and the Dividend
Discount Model our group believes that the current stock price is an
accurate reflection of future earnings.
We believe CVS will continue to generate excellent revenues as it is
well established and has a proven business model. While the Drugstore
market is fiercely competitive we feel that CVS has enough brand
awareness and product differentiation to remain stable. As CVS
continues to grow their Specialty Drug segment we feel that their
revenues will be positively affected. While our analysis shows that CVS
is currently correctly priced, we feel that CVS will definitely benefit in
the future from macroeconomic factors, like the aging population,
brand name drugs transferring over to generic, and the changing
landscape of US Healthcare. We recommend a HOLD.

CVS Company Valuation

Bibliography
1.) "Investors." Investor Relations. N.p., n.d. Web. 07 Apr. 2015.
(Annual Report)
2.) Capital IQ. Mcgraw Hill, n.d. Web. 7 Apr. 2015.
<https://www.capitaliq.com>.
3.) "CVS Health Corporation." Yahoo! Finance. N.p., n.d. Web. 07 Apr.
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s=CVS&fr=uh3_finance_web&uhb=uhb2>.
4.) "Investors." Investor Relations. N.p., n.d. Web. 07 Apr. 2015. (10k
Report)
5.) "Specialty Costs: Can They Be Contained?" CVS Health. N.p., n.d.
Web. 07 Apr. 2015. <http://www.cvshealth.com/researchinsights/cvs-health-research-institute/specialty-costs-can-theybe-contained>.
6.) "CVS Health Gross Profit Margin (Quarterly):." CVS Health Gross
Profit Margin (Quarterly) (CVS). N.p., n.d. Web. 07 Apr. 2015.
<http://ycharts.com/companies/CVS/gross_profit_margin>.
7.) "CVS Caremark | SWOT Analysis | BrandGuide | MBA SkoolStudy.Learn.Share." MBA Skool-Study.Learn.Share. N.p., n.d. Web.
08 Apr. 2015. <http://www.mbaskool.com/brandguide/lifestyleand-retail/4306-cvs-caremark.html>.
8.) "Marketing Mixx." Marketing Mixx RSS. N.p., 13 Jan. 2015. Web.
08 Apr. 2015. <http://marketingmixx.com/marketing-basics/swotanalysis-marketing-basics/176-cvs-caremark-swotanalysis.html>.
9.) Weighted Average Cost Of Capital (WACC) Definition |
Investopedia." Investopedia. N.p., 18 Nov. 2003. Web. 08 Apr.
2015. <http://www.investopedia.com/terms/w/wacc.asp>.
NOTE:

CVS Company Valuation

All tables were constructed in Excel by our group, based on
numbers pulled from Capital IQ, or GuruFocus.