The Long and Short

Preliminary opioid settlement a plus for pharmacy retailers

| November 4, 2022

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

The largest national pharmacy retailers have now agreed on a $13 billion settlement for their role in the national opioid crisis, and that is a positive for their credit.  Not only does the settlement resolve all existing claims against CVS, Walgreens and Walmart, but it also helps lift the shroud of financial uncertainty that has plagued all three since litigation started more than five years ago.  This should allow each company to continue investing in their businesses while putting further safeguards in place to fight opioid abuse.  Given its relatively more diversified revenue base and stronger free cash flow, CVS should get a particular boost from the news.

Settlement Comparison

CVS has agreed to pay approximately $5 billion which is expected to be broken down into a $4.9 billion state and political subdivision payment and a $130 million payment to Native American tribes. CVS will have a 10-year time horizon to make the payments with its first payment beginning in fiscal 2023.  WBA has agreed to a remediation payment of $4.95 billion, to be paid over a 15-year time frame.  While WBA did not break down the payment in its press release, it is estimates that $155 million of its payment will be to the tribes.  That said, CVS will pay $500 million annually versus $333 million for WBA.  While the longer time horizon is a positive for WBA, CVS benefits from a much stronger free cash flow profile, providing more financial flexibility to make the payments while continuing to invest in future growth (Exhibit 1).

Exhibit 1. CVS vs. WBA LTM Free Cash Flow Comparison

Source: Company Reports; APS

Furthermore, with the acquisition of Aetna (AET) back in 2018, CVS has evolved into a healthcare company, versus a traditional retail pharmacy.  This provides CVS with a much more diverse revenue stream while alleviating the need for significant investments in the business to move away from traditional brick-and-mortar pharmacy operations.  The pandemic proved positive for CVS as its free cash flow grew roughly 52% from year-end 2019 to year-end 2021.  This enabled CVS to rapidly repay debt associated with the AET acquisition with leverage now back at its target level. Over the same period, WBA’s free cash flow contracted 11%, which has restricted management’s ability to invest in growth opportunities that broaden its revenue scope.

CVS Reports Another Strong Quarter

Shortly after the opioid settlement announcement, CVS posted strong 3Q results which came in ahead consensus estimates on every metric.  Consolidated revenues grew 10% in the quarter, driven by solid growth across all segments.  Both the Health Care Benefits and Pharmacy Services segments witnessed double-digit growth, while the Retail/LTC segment posted 7% growth.  Importantly, in the Healthcare Benefits Segment, the Medical Benefit ratio declined 230bps year-over-year, reflecting improved cost performance versus prior period estimates.  Cash from operations was very strong, with CVS generating over $18 billion year-to-date.  The strong cash generation has helped to fuel further debt reduction, with CVS having repaid $4.1 billion of total debt so far this year.

Given the strong operating performance, CVS increased its full year cash flow and EPS guidance.  CVS now expects adjusted EPS to be in the $8.55-$8.65 range, an increase from the $8.40-$8.60 previously guided.  Cash from operations is now expected to be $1 billion higher than previous expectations, to a range of $13.5 billion-$14.5 billion. During the quarter, CVS recorded a pre-tax charge of $5.2 billion related to the estimated liability for the opioid related claims.  The preliminary opioid settlement allows CVS to now focus on its acquisition of Signify, which is expected to close by 6/30/23.

Meredith Contente
meredith.contente@santander.us
1 (646) 776-7753

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