Yahoo Finance Why CVS’ Profitability Declined in 2Q15
CVS in 2Q15: Ahead of Consensus on Earnings, Misses on Revenue
Analyzing CVS Health’s profitability drivers in 2Q15
CVS Health’s (CVS) gross margins deleveraged in 2Q15 by 1.05% to come in at 17.2%. The decline was primarily due to the lower-margin and larger Pharmacy Benefit Margin (or PBM) segment sales growing faster than the company’s Retail Pharmacy segment. Margins for both segments fell.
Segment analysis
CVS reported an unfavorable comparison to last year’s Medicaid reimbursement rates, which had benefited both of its segments in 2Q14. This factor had raised 2Q14 sales by $16 million for the PBM segment and $53 million for the Retail Pharmacy segment.
Gross margin for the PBM segment came in at 5.1% in 2Q15, a decrease of 0.4% year-over-year (or YoY). Plus, price compression trends in the business continued and are likely to remain a feature in the coming quarters as well.
Retail Pharmacy margins contracted by 0.55% to come in at 30.9% in 2Q15. Margins were unfavorably impacted by a shift in the sales mix toward the pharmacy side of the business, from the front store.
Margins upside
As discussed earlier in the series, the generic dispensing rate (or GDR) rose for both segments rose by 1.5% each, which reduced the pressure on profitability. Generic drugs typically earn higher margins. The discontinuation of tobacco products also benefited the company’s margins.
Red Oak Sourcing
CVS also reported an improvement in purchasing economies for the pharmacy business, due to its 50–50 joint venture with Cardinal Health (CAH), Red Oak Sourcing. CVS is anticipating a $10 million higher payment from CAH under this venture in 3Q15 due to the achievement of unspecified targets.
Peer group comparison
The larger tilt toward the PBM business in CVS’ sales mix is the primary reason the company’s gross margins are trailing peers Walgreens Boots Alliance (WBA) and Rite Aid (RAD). The gross margin for CVS came in at 17.6% in the trailing 12 months, compared with 26.6% for WBA and 28.6% for RAD. Both primarily operate in the retail pharmacy business.
The S&P 500 Index (IVV) and the S&P 500 Food & Staples Retail Index (XLP) had margins of 32.7% and 21.7%, respectively. Diplomat Pharmacy (DPLO), which operates a specialty mail-order pharmacy model, clocked a gross margin of 6.3%. Specialty pharmacy drugs are typically costlier and earn lower margins.
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