A rebuilding year.
That's how CVS Health (NYSE: CVS) CEO Larry Merlo has referenced 2017 in the past. The rebuilding is needed because the large pharmacy services company lost two major contracts in the final four months of 2016 to rival Walgreens Boots Alliance (NASDAQ: WBA).
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CVS Health started out 2017 by posting better-than-expected earnings in the first quarter. The company announces its second-quarter results on Aug. 8. Here are three things you should watch for in CVS Health's quarterly update.
1. Timing factors
CVS Health's second-quarter performance hinged in large part on several timing factors. One of the most important things to look for is the impact of generic drug launches. The introduction of new generics in the first quarter hurt year-over-year pharmacy sales comparisons. On the other hand, generics help improve profits for CVS Health's pharmacy benefits management (PBM) business and its retail/long-term care (LTC) segment.
The calendar also plays a key role in sales for CVS Health's retail pharmacy business. In 2017, Easter fell in the second quarter instead of the first quarter as it did last year. Easter is typically a strong time of year for the company's stores, so this shift could boost revenue somewhat.
One area where timing will definitely hurt CVS Health's second-quarter numbers is in its free cash flow. The company generated $3.1 billion in free cash flow in the first quarter, thanks primarily to receiving a big Medicare Part D payment. CVS expects full-year 2017 free cash flow between $6 billion and $6.4 billion, so expect a big drop-off in the second quarter.
2. Profit margin pressure
Look for continued pressure on profit margin in the second quarter. The key question, though, is just how much CVS Health's margin will be squeezed.
The major factor resulting in lower margin for the company is the rates of growth for its two business segments. CVS Health's PBM business is growing faster than its retail/LTC business. The bad news with that is the PBM segment has lower margins than the retail/LTC business does.
There are two positives for CVS Health that could help improve margins in the second quarter. The company has enjoyed some success with its personalization and promotional strategies in its stores, which could provide a boost to profit margins. Increased generic dispensing rates could also help.
On the other hand, there are potentially a couple of negative spots that could hold down margins. The biggie is pressure on pricing in both the PBM and retail/LTC segments. CVS Health also will experience some higher retail store expenses that didn't impact the first quarter, although how much of those expenses hit in the second quarter versus later in the year remains to be seen.
3. Selling season numbers for PBM
Perhaps the most important numbers that CVS Health will announce won't be in the second-quarter financial statements. The company is expected to provide more details on the selling season for its PBM business in its second-quarter update.
In May, Larry Merlo stated that the company was off to a good start for the 2018 selling season. He said then that CVS Health had completed roughly 43% of client renewals -- higher than than the renewal rate at the same point in 2016. However, Merlo also mentioned that the scale of bidding opportunities was flat to down compared to the previous year.
CVS Health's other second-quarter results will be about the past. The company's PBM selling season numbers, however, should give investors a better feel for how strong the company's earnings next year might be.
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