CVS Health Corporation (CVS) Earnings Call Transcript & Summary

Welcome, everyone, and thank you for joining us today in this next session of Morgan Stanley's Global Healthcare Conference. I'm Ricky Goldwasser, and I'm Morgan Stanley's health care services analyst. It's a real pleasure to have CVS executive team here: Karen Lynch, CVS' CEO; and Alan Lotvin, CVS Caremark, EVP and President. Before we get started, just wanted to call your attention for something that's very near and dear for us here at Morgan Stanley, the Morgan Stanley Alliance for Children's Mental Health that uses the resources of the Morgan Stanley Foundation in collaboration with the expertise of our key nonprofit member organization in the mental health space to help address children's mental health, specifically the far-reaching challenges of stress, anxiety and depression. And now, more than ever, we do need urgent, coordinated efforts to prevent the existing global crisis in children's mental health from escalating, and all of us can play a role in this effort. So we encourage everyone to learn more about the issue that children are facing around their mental health and become advocate for change and you can learn more by visiting our website at the Mental Health Alliance. And please just note that the webcast is for Morgan Stanley's clients and not for the members of the press. And for any Morgan Stanley research disclosures, you can see them at our website: morganstanley.com/researchdisclosures. And with that, Karen, Alan, great to have you here. Thanks for being with us. And Karen, we just hand it off to you for a couple of introductory remarks to help frame our conversation.

Well, good morning, everyone, and good morning, Ricky. And first of all, let me just applaud you and Morgan Stanley for your efforts in children's mental health. That is outstanding and what a great contribution for the company. I'll just say a few remarks, Ricky, and turn it over to you. But just as a reminder, CVS Health has become one of the most trusted consumer brands in America. And our presence in communities across the country is allowing us to meet consumers where they are, and we are becoming a bigger part of their everyday health like no other company can be. With the major shifts that we've seen this year, the last 1.5 years with COVID, we have seen dramatic changes in consumer behaviors, and we've seen increases in virtual health and digital health. And it is changing the entire landscape of health care, and consumers are expecting convenience, simplicity, personalization. And this reinforces our strategy and our importance of local affordable health care. We have been successfully positioning CVS Health as a health care company. And we are looking at our company from the delivery of financing mechanisms through our health insurance products, through our Aetna business, and our Caremark business to the delivery of care for whole health needs through our retail assets in the local communities, our home services like Coram and our digital engagement capabilities and our virtual engagement capabilities. And third, we're managing the care for specific health care issues through our clinical programs like our diabetes and oncology programs with our face-to-face interactions and our virtual interactions. And clearly, we are able to bring together a unique set and combination of assets to meet consumer health needs. Our second quarter results were very strong. We delivered revenue growth of 11%. We generated cash flow from operations of $5.8 billion. We raised our EPS guidance for the year, and we outperformed both our sales and earnings goals. And lastly, I would just say, Ricky, that our work to help test and vaccinate America is a powerful example of the relationships that we have with consumers. And I'd be remiss if I didn't thank the 300,000 colleagues that have been on the front lines every day to help Americans prevail against the pandemic. And you talked about the changing landscape of health care, so let me turn it over to you, and I look forward to answering your questions.

Great. So Karen, you have a long tenure in the managed care industry, Cigna, Magellan, Aetna, and CVS has these unique assets really breaking the mold, trying to do things differently. How do you use these different assets that you own to get ahead of everybody else, to get ahead of your peers?

Well, first of all, don't remind me how long I've been in the health care industry, Ricky. But let me just share sort of some of the unique ways that we've -- we're positioned to really exceed consumer expectations. As I said on the outset, we are one of the most respected and trusted consumer brands. We have set a broad set and delivered a broad set of innovative solutions that are meeting the holistic needs of individuals. We have a broad range of clinically oriented digital health care products and services. And quite frankly, we have an expansive footprint of services in the local communities that provide different access points for consumers' health needs. And as you know, we have the ability to seamlessly engage consumers across the continuum of health care. We have over 100 million customers that are loyal to both Caremark and Aetna, and we have the opportunity to increase penetration through those unique assets to increase share of wallet. As you know, Ricky, we've expanded our consumer base with testing and vaccines. And we're building integrated platforms to broaden or manage our local management programs like our diabetes, like our pharmacist panels. We've been expanding over the course of the last year into virtual care, into primary care services, and we'll continue to expand there. And we've been expanding into behavioral health as well. What's different about us is, we offer a fully integrated set of health solutions. And we have -- in addition to that, we have access for health benefits designed to support those CVS assets. And one example is how we're using our benefit designs in Aetna to have over 7 million people directly targeted to support MinuteClinics and our HealthHUBs. And data and analytics is critical to our strategy, and we're using that for predictive capabilities to demonstrate our opportunity to reduce medical spend and increase engagement because really what we are trying to do as a company is, use our consumer experience as our differentiator and engage our customers to reduce medical costs.

So Karen, when we think about the retail presence, to your point, it's an important asset that connects you with the local communities, and it does offer the proximity to the member that other organizations don't have. But it's also capital-intensive and it hasn't really changed in decades and while how consumers and patients and all of us shop, has. So you have said on prior calls that you have too many physical pharmacy locations. How are you going about defining what's the right number of stores? And how do you think about balancing long-term returns versus earnings power that these stores generate?

Ricky, I appreciate the question. And I think what was important for us through the pandemic, and it really shined a spotlight clearly on the importance of having that local access and being in the communities. And we, to date, have delivered over 34 million vaccines and 32 million tests. So obviously, being in the communities, engaging consumers in their health care needs is really critically important. As I've said, we are evaluating our footprint. We are looking at different types of services in our footprint. So what I'd like you to think about is, having us have the ability to have certain stores have extended primary care and extended health services. And that would be a small group of stores. Then we'll continue to evolve our HealthHUB and expand our services and our HealthHUBs and continue to have pharmacies and health products in those HealthHUBs. And then we'll still continue to have -- but we will optimize kind of that broader set of stores that are similar to the stores that we have today, but those will be optimized. We'll look at obviously coverage, where our customers needs and where we can meet those needs. So that's how we're thinking about it. Clearly, we recognize that there's reimbursement pressures in the front stores -- I mean, in the back of the store, and we will continue to evaluate our footprint and optimize the number of stores that we have.

And you talked about sort of evolving the HealthHUBs. Similar to retail locations, what factors are you taking into consideration when you're evaluating where do you open a HealthHUB and what goes into it?

Yes. So what we've done is we've really looked at our -- where our members are both on the Aetna side and on the CVS Caremark side. And that's where -- when we look at our HealthHUBs, it's really more about coverage. And it's really more about how do we engage consumers in their health care, how do we help them go to lower sites of care. Clearly, HealthHUB is a lower site of care. How do we -- you kind of meet them through their individual doctors' appointments, kind of when they see their doctors on kind of once a year. We're there to meet them for those services throughout the year, so -- and we're engaging them with their -- they're picking up their meds, so we're engaging them in various ways. We've expanded into the behavioral health arena. We've actually been seeing good repeat customers. So we know that people will come to these local community health destinations, is really what I'd like to call them. I really, really want people to think about CVS Health as a health care company. It is far more than just a corner drugstore. We really have expanded our scope of capabilities in that end, and the services that we've put in our HealthHUBs have a broad array to meet consumer needs when they need their health.

Great. And for everybody listening to us, if you want to ask Karen question, please just type it into the browser, and thank you for those who already did. So moving on to the managed care side, we've got some questions from the audience on that. Let's start with Medicare Advantage. Investors always perceived Aetna as having a commercial focus, but really if you think about your risk book, you have about 10% -- you manage 10% of Medicare Advantage lives. I think it's over 35 of your risk lives. Where do you see opportunities to leverage the enterprise to make you more competitive in MA? And also, how are you leveraging your commercial scale?

Yes, Ricky. So let's start with Medicare because I think it's important if you have to step back and really understand that we have a broad Medicare portfolio. So we have the ability -- we have MedSup products. We have group Medicare and we have individual Medicare and we also have PDP. So we have to really broaden our thinking around when people are looking for Medicare, do we have all the products they need and we certainly do. If we think -- if we want to just focus on individual Medicare Advantage for a moment, what I would say is, 50% of our revenues are Medicare in our Aetna book. So we have been building that business very deliberately over the course of the last number of years. Over 7 years we were outpacing the industry growth, and we had a little bit of a -- we thought we would be higher than industry growth in 2021. We're at industry growth, so really strong results there. We currently are at about 84% of the Medicare-eligible population with our footprint and we expect to have that to be over 85% in 2022 and we've been continuing to grow share with our existing footprint. So in fact, 85% of our growth in 2020 and 2021 came from our existing footprint. So the other, obviously, we've talked a lot about this. What's important is STARs performance. And 83% of our Medicare members are in 4+ star-rated plans. So where is the opportunity for growth here? Clearly, to continue to expand our footprint, continue to deepen our membership growth in the existing footprint, we have the ability to convert. We are the largest PDP company in America. We have the ability to convert PDP to Medicare Advantage. We have the ability to convert our MedSup to Medicare Advantage and we have the opportunity to grow in DSNP, so there -- and we have the opportunity to grow in our group Medicare business. So all-in, there are significant growth opportunities in Medicare as we look towards the future. And then, you mentioned commercial. Clearly, that's a market that has -- it's a flat market. We have obviously a variety of products in the commercial space. I would say that you can expect for 2021, we've seen with the labor market, what we said in the second quarter, we'll continue to see some attrition given to kind of in-group growth. But as we turn the corner to 2022, we've introduced new products into the marketplace. We've got an Aetna-connected product. We've got our virtual primary care first product. And we should expect to see national account growth as we turn the corner in 2022. We've had very strong retention. I think I mentioned the second quarter is around 97%. So we're -- we expect to continue to maintain our pricing discipline in commercial, and we'll continue to hold our own in the commercial market.

On the point of price care, and one of the questions we got here, I'm looking at the questions from the audience is, really about the pricing environment on the commercial side. It's defined here as a little bit of sort of volatile. What does it mean exactly?

Well, I would say the pricing environment and the commercial side continues to remain competitive. There's not anything that we're seeing that's unusual. Obviously, it varies by market. And when I talk about pricing, I'm talking about the fully insured pricing markets. Obviously, we had to take into consideration a variety of factors given the uncertainty of COVID. But what I would say is it's a rational pricing market out there. And we're not seeing anything crazy in the market.

Another question that we got here really refers to just the model. And what metrics or what KPI should we look to that will demonstrate how you deliver a care model is impacting health outcomes?

I'm sorry, Ricky. So are you looking for the care model? Is that what you said, the care model?

Yes. And the question is really what metrics, right, are there that you can share with investors that show how this kind of like care model are putting kind of like the assets together, are impacting outcomes?

Yes. So I would say a couple of things on the health outcomes. One is we -- you obviously want to look at our -- at the most macro level our MBRs, right? So we'll start there. The second thing I would say is, you want to start with -- the second thing at the macro level, are we growing membership because people view our products and our services as unique and differentiated in the market. And then if you think about kind of the things that we look at, is there engagement in lower sites of care? Have we reduced ER admissions? Have we seen improvement in adherence and pharmacy? Have we seen sort of the kind of the reduction in -- oh, I said ER. So those are the kinds of things that we would continue to look at and evaluate relative to total medical costs. And are we seeing shorter, lower inpatient stays? Are we seeing adherence to your diabetes regimen? Are you seeing -- so there's a series of details that we look at on an everyday basis? But those would be some of the things that we can share and then kind of the macro, obviously, is what you'd see kind of published externally. Do you want to say anything, Alan? Hold on. Let him see if I miss anything.

I would -- the only thing I would add would be, readmit rate.

Readmits, yes.

Another question that we got here is, your strategy in kidney care and dialysis?

Yes, let me -- I'll have to transfer to Alan.

Yes, so we started out in kidney care and dialysis a couple of years back recognizing that there was an enormous unmet clinical need and that unmet clinical need would translate into far superior health outcome. So what we've built over the past couple of years is an ecosystem that's designed to identify people earlier in their course, slow their progression to dialysis to allow more time for transplantation. If they're going to head towards dialysis, ensure that they have a good understanding of all the options, right? 95% of nephrologists say, they would choose home hemodialysis, yet less than 5% or 10% of people are offered that. And then tie that to an innovative device to facilitate home hemodialysis that we're in the middle of a clinical trial. So it's a care management approach. It's a dialysis services delivery approach, delivering home care on dialysis, and it's a device. So it's a complete sort of end-to-end package that looks, first and foremost, at health outcomes. But because of the expense of this population, better health outcome translates directly into far lower costs.

I think a really good example, right, of how the different parts of the organization can come together to deliver these better outcomes?

Yes. We -- when we looked at this early on, we thought that the local footprint would be a great opportunity to do training, to do education, as we brought the organizations together. We're doing pilots right now in value-based care with the Aetna market team. So it's really, to your point, Ricky, we're using each part of the organization to support and accelerate, I would say, the commercialization of the different parts of the kidney care business.

So we have a question here on capital deployment. So I'll leave it into to some of the questions I have. You're in target to bring your leverage to below 3x, how do you prioritize returning cash to shareholders, internal investments and then also future M&A?

Yes. Thank you. So obviously, Ricky, we are generating really good cash flow. And we -- since the close of the transaction, we paid off $17.6 billion debt. So we have about $4 billion that we'll pay in 2022. So obviously, that gives us an opportunity for -- to assess capital deployment for next year. We take a very balanced approach to it, Ricky. Obviously, we'll look to do some continued investment in our business to support profitable growth, kind of long-term profitable growth. And then we'll look at opportunities for share repurchase and dividend growth. So we'll have a very balanced perspective as we think about returning our share -- returning growth to shareholders.

And you talk about investments to support -- in the business to support long-term growth. I think, in the past, you talked about adding some capabilities in home health, clearly, a very pivotal part of providing care and more so in the future. You also talk about primary care. When you think about adding these capabilities, what model do you think fits this sort of your philosophy? Is it partnering? Or is it acquiring?

Ricky, I think we are very focused on building broader capabilities, either in the home health space, in virtual care, extending into primary health services. So we think that our strategy will be to invest in those areas using several approaches. We'll look to partner, we'll look to acquire, we'll look to build, and we'll look to make sure that we're doing the most appropriate strategy to support kind of where we're headed. So just think about it in kind of a broad array. There's not kind of a one-size-fits-all here.

And earnings power, clearly, on top of investors' minds. On the last earnings call, Shawn highlighted some of the headwinds into next year. When we think about the balance, right, what are the tailwinds we should consider as we think about 2022?

Well, let me just kind of step back and talk a little bit about 2022. First of all, we are -- all of our core businesses are well-positioned, and we have the opportunity to build on the strength of those results. So obviously, Shawn mentioned that a lot has changed since 2019. So as we think about 2022, I think, it's reasonable to expect that we'll have -- we have a very strong selling season in our pharmacy segment, our commercial national accounts, as I mentioned. We would expect -- now who knows, but we would expect to see lower COVID-related health care costs. We would expect to see improved Medicare risk adjuster -- risk adjustment reimbursement. And we expect to seek an improvement in our health care segment. And obviously, we've mentioned this before, we should expect to see continued contributions from our ongoing cost initiatives. But those are sort of some of the tailwinds. I would just remind you that there are some headwinds that we have and will continue to mitigate. You think about our pharmacy reimbursement pressure. We're working to mitigate that. Obviously, the impact of the minimum wage announcement that I made in the second quarter. And then, obviously, some uncertainty around where vaccines and testing. Clearly, we've had a big contribution this year. Boosters were not in it. So that will be some upside. But I would just say those are some of the things to consider from a balance perspective. But I'm very confident that we'll have a strong year in 2022.

Great. And you mentioned as we think about 2022, a very strong year on the pharmacy services side and a good selling season. One of the questions we got here from the audience, if you can comment on these cost strengths and PBM growth.

Go ahead, Alan.

Yes. So I think the growth of the PBM is sort of driven by a couple of things: So one is, we do bring a set of differentiated products to market, right? So if you think about specialty as an example, what we're able to do for members and physicians, both through the retail stores as well as through our digital technology really makes a difference. When you think about specialty, the focus on cost management and specialty is what resonates with our customers. So those two things are driving kind of the differentiation in the marketplace in the area that's most important to our customers. I think the other couple of things that have really resonated is, we've built and are continuing to build a reputation for transparency, trust and service within the PBM. So we are routinely being scored highest by consultants. So it's not just me saying it. And then the for want of a better term, sticking to the knitting, right, where we're doing a great job of driving more value out of the pharmaceutical manufacturers, who are doing a great job. The team is doing a great job of managing all of our various pricing guarantees to our customers. So that's kind of a driver. And then the last one, which I didn't touch on was, we've had a successful selling season in the integrated market, working very, very closely with Dan Finke's health care benefits team. We've built an integrated business unit that manages these joint customers. It's the only one in the industry that works across these enterprises. And that group has been very successful in both expanding as well as winning net new business for both Caremark, Aetna and a whole host of the affiliated Aetna products.

So we have time for 1 more question. Karen, it will be 2 parts. So you are hosting a, very anticipated for us, Investor Day coming up in December. So one, what should we be looking for out of the day? And then, secondly, I mean, you and Shawn and Alan, you've been on the virtual road meeting with investors, what do you think the market is still missing about the story that they'll better understand either after the Analyst Day or 12 months from now?

Yes. So Ricky, on Investor Day, what you should expect to see is we will lay out our strategy. We'll lay out our long-term financial targets. We'll give you 2022 priorities and 2022 guidance. We'll give you our capital deployment strategy and we'll give you that roadmap for our strategy holistically. So that's what you can expect and you'll get to meet the management team as well. So that's what you can expect to see on December 9, and we're looking forward to seeing you all in New York. And then I don't know that people are missing anything about our story. What I would say, Ricky, is we're really pivoting sort of the view of what CVS Health is, to really be a health solutions company or a health care company and as I mentioned on the outset, we have unmatched assets in the company. We can support from the financing of insurance to the delivery of care, to the management of care, and be in the local communities. We can be in the home and we can connect with people digitally. So we clearly -- going forward, what you should expect from us is that you'll see growth in our core businesses that you should expect us to capture more of the share of the health care wallet with our overall assets, and that will continue to deliver on the financial commitments that we make. So I would just leave you one comment and that we are unequivocally demonstrating the value of our -- bringing these businesses together and to meet the consumers' needs.

Karen, Alan, thank you so much for the time and the conversation. And for everybody joining us, thank you for tuning in and for all your questions.

Thanks, Ricky. Nice to see you.