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CVS Health Corporation (NYSE: CVS) turned in solid financial results in the first and second quarters of 2016.However, that hasn't translate to share price gains for the giant pharmacy services company. CVS Health's share price has gone nowhere this year.
If good news isn't helping the company's stock performance, then you have to wonder if bad news could have a serious negative impact on shares. So what bad news could cause CVS shares to drop? Here are three possibilities.
1. Disappointing specialty drug sales
There were so many positives in CVS' second-quarter results that finding problem areas wasn't easy. However, there was one notable weak spot in the second quarter: specialty drug revenue.
CVS Health reported solid year-over-year growth in its pharmacy benefits management (PBM) business, but that increase stemmed primarily from the acquisition of pharmacy services company Omnicare. Second-quarter revenue for the segment actually came in below the company's expectations. The main culprit was a decline in hepatitis C prescription volume.It remains to be seen whether hep C utilization will pick back up in the second half of the year.Furthermore, given that the Omnicare deal closed in August 2015,CVS won't be able to rely on that acquisition to produce attractive year-over-year comparisons much longer.
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Don't underestimate how important specialty drug revenue is to CVS Health. The company's PBM business generates roughly two-thirds of total revenue,and specialty drugs are key to that segment's success.
2. Pressure on margins
Another potential issue hidden among all the great second-quarter numbers was CVS Health's shrinking margins.
In the PBM unit, gross profit margin fell from 5.1% to 4.6% year over year, while operating declined from 3.8% to 3.5%. In CVS' retail/long-term care segment, gross margin dropped from 30.9%to 29.2% year over year, while operating margin decreased from 9.7% to 8.5%.
When revenue increases but margins decrease, it means one thing: Costs are rising faster than sales. So far, the falling margins don't seem to have worried investors. However, a sustained negative trend could ultimately take a toll on CVS Health's shares.
3. Macroeconomic woes
You've probably heard the old saying that a rising tide lifts all boats. Well, a sinkingtide does the opposite. If the U.S. economy dives, then CVS Health will be pulled down with it.
In the event of significant economic troubles, CVS' weak spot would likely be its retail business -- particularly front-store sales. CVS Health president Larry Merlo mentioned in the company's second-quarter earnings call that front-store sales account for about 11% of total revenue. Lower sales caused by a weak economy would certainly hurt CVS.
Other areas of CVS Health could also be affected. Potential PBM customers would be even more focused on lowering costs in a challenging economy. That could prompt rivals to cut costs in order to steal business from CVS.
Express Scripts (NASDAQ: ESRX) would be a likely suspect to make a play for CVS Health's PBM customers. While CVS' PBM profit margins are relatively low, Express Scripts posted a gross profit margin of 8.6% in the second quarter. That gives the big PBM more room to cut costs in a tougher economic climate while still retaining solid profitability.
A glass half full
Any or all of these three factors could cause CVS Health's stock to fall in the months ahead. Investors shouldn't worry too much, though. The company has a lot going for it.
I suspect that CVS won't struggle with continued declines in hepatitis C specialty drug sales. Gilead Sciences won approval for its newest hep C drug, Epclusa, at the end of second quarter. My guess is that Epclusa could help spark a rebound in hep C sales all by itself.
CVS Health's margins might be falling, but the sky isn't. The company remains profitable. Those lower margins stem in large part from a change in CVS Health's mix of business, which is partly the result of the Omnicare acquisition.
The U.S. economy could face headwinds, but CVS Health (and rivals like Express Scripts) benefit from several advantages. Patients still need their medications.Organizations will need to control prescription drug costs during difficult economic times just like they need to during good times.
We can imagine clouds on the horizon with any stock; CVS Health is no exception. Overall, though, my view is that the company is on sound footing, and its stock remains a good long-term investment choice. This glass still looks half full.
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Keith Speights owns shares of Express Scripts and Gilead Sciences, and The Motley Fool owns shares of and recommends both companies. The Motley Fool has the following options: short October 2016 $85 calls on Gilead Sciences. The Motley Fool recommends CVS Health. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.