How CVS Health Corporation Makes Most of Its Money

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CVS Health Corp. (NYSE: CVS) raked in a stunning $177.5 billion last year. To reach this enormous sum, every man, woman, and child in the U.S. would have had to chip in about $548. I know I didn't spend that much at CVS pharmacies last year, and I'll bet most of you didn't, either.

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Where does all that money come from? Well, multiple sales channels flow into CVS Health's total revenue stream. One outweighs all others, and it probably isn't the one you're most familiar with.

The giant between drugmakers and end payers

The single largest component of CVS Health's top line is its pharmacy benefits manager, which is basically a middleman between companies that make drugs and the PBM's clients. Last year, CVS Health's PBM filled or managed a whopping 1.6 billion prescriptions, and in the process generated $120.0 billion in revenue.

Investors will be glad to know CVS Health's massive PBM keeps getting bigger. In the first quarter, the company recorded about $31.2 billion in revenue from 376.8 million prescription claims processed. One reason the company's PBM revenue is growing steadily has to do with America's increasing reliance on drugs. In 2016, total spending on prescription medicines rose 5.8% over 2015 levels to $450 billion based on list prices, or 4.8% to $323 billion after adjusting for discounts that PBMs secure for their clients by haggling with drugmakers.

Overall spending trends aren't the only reason we can reasonably expect CVS Health's PBM revenue to continue climbing over the long term. Representing more patients gives a PBM greater leverage to negotiate lower prices from drugmakers, and CVS Health has more leverage than any of its competitors. Last year, it pulled ahead of its main rival in the space, Express Scripts (NASDAQ: ESRX), which reported $100.3 billion in revenue after processing 1.4 billion claims. If Anthem refuses to renew its contract with Express Scripts in 2019, as it's widely expected to do, CVS Health's lead could widen much more.

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How CVS Health makes most of its profit

Although the company's PBM is responsible for a majority of its top line, margins in this industry are terribly slim. During the first quarter, CVS Health squeezed out an operating profit of just $784 million from a whopping $31.2 billion in pharmacy services revenue.

CVS Health bundles its retail and long-term care operations into a single segment that delivered $1.41 billion in operating profit from $19.3 billion in revenue during the first quarter this year. This means when it comes to generating profits the company can return to shareholders, its retail and long-term care operations are far and away the most important.

Late last year, CVS Health announced an expected loss of about 40 million prescriptions due to new pharmacy network restrictions enacted by various insurers. As a result, same-store sales fell about 4.7% in the first quarter as fewer customers entered them to get their prescriptions filled.

Looking ahead, I expect the segment to return to growth. The company hasn't announced any more network restrictions, and its recent acquisition of Omnicare gives it a big presence in the increasingly important long-term care market.

Each day, roughly 10,000 baby boomers turn 65, and they're expected to outlive previous generations. The long-term care facilities that will eventually house many of America's older adults buy a lot of prescription drugs. By acquiring Omnicare, CVS Health took on 152 spoke pharmacies that handle new prescription orders for long-term care facilities, 32 of which employ automation technology to manage refills for the other spokes.

Getting customers to buy more medicines and other goods for sale within the company's network of 9,676 retail locations hasn't been easy lately. Luckily, its MinuteClinic program is exceeding expectations. The same-store sales decline reported during the first quarter excludes revenue generated by the company's walk-in clinics. Compared to the year-ago period, the MinuteClinic program generated 15% more revenue.

With 1,125 walk-in clinics spread throughout 33 states, CVS Health now operates the country's largest network of such facilities. That's a big network, but the company still had 8,551 locations without MinuteClinics at the end of March, which suggests the program has a lot of room to grow.

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Cory Renauer has no position in any stocks mentioned. The Motley Fool owns shares of Express Scripts. The Motley Fool recommends CVS Health. The Motley Fool has a disclosure policy.