CVS Health Corporation (CVS) Earnings Call Transcript & Summary

Hi, everyone. I'm A.J. Rice, the health care service analyst at Credit Suisse. We're very pleased to have up next presenting, CVS. We have Shawn Guertin, Chief Financial Officer; and Susie Lisa, Senior Vice President of Investor Relations. Thank you guys for participating once again in our conference.

Shawn, you joined CVS earlier this year with a few months under your belt now. What have been your major learnings? So sort of open with a pretty high-level question, what have been some positive surprises? What have been the challenges that you're seeing?

Yes. No. Thanks, A.J., and good morning, everyone. Overall, I would say I haven't really been surprised by anything. I would say on the -- I would say on the challenge side, a lot of the challenges certainly that I was aware of from the outside and that you all talk about that face the PBM or face pharmacy, they're quite real, and they're of a significant magnitude. And I would say, again, that maybe the size of that when I really got in was more eye-opening to me than I expected. But I think I also sort of saw the sort of the size and the sophistication of some of these assets as well to kind of confront those challenges. I think on the other side, I continue to be struck by, I think, how much opportunity exists going forward. And as I mentioned, I think there are some very strong franchises here. The government business, in particular, the Medicare business in health care benefits has continued to be a very strong franchise. The scale and sophistication of Caremark is obviously a very strong asset that we go into this with. And we do have a great deal of understanding on the consumer front, too. I think the other thing that I thought about on the outside but I continue to think about as the quarters have progressed here is when I think about the ability, in fairly short order, to scale up and do 44 million vaccines and 30 million COVID tests and produce revenue in excess of $3 billion this year. I acknowledge it's being fueled by extraordinary circumstances and unprecedented circumstances, but on the other hand, it really kind of demonstrates to me the latent power that exists in a model that's national in scale but locally deployed, which, in many ways, is the idea behind the entire enterprise. I think the other thing I remind myself of a lot is just the size and scale and capital generation ability of this business. Before we deploy that capital, throwing off $12 billion, $13 billion of free cash flow, it is significant. And as we kind of wind down delevering, that becomes a very powerful tool that we have to deploy.

Yes. That's great. That's great. And even you're relatively new, coming back to the company, but Karen took over as CEO at the beginning of the year. I think there's been quite a bit of management changes and upgrades, I guess, that would be the word to use. Can you maybe walk us through a little bit of the changes she's made and that the company has seen since she's taken over and some divisional operations?

Yes. I think there's a number of things. One of them, though, that is, I think, philosophical that has governed a lot of it is her reorienting the company and the management team to think about ourselves as a health solutions company or even a health services company broadly as opposed to just a retail or a pharmacy-specific company and changing that orientation in terms of how we just think about our mission, and a company, though, that will have a keen focus on consumer. And so to your point, she brought in a woman named Michelle Peluso, who is not only helping us in digital marketing but is our Chief Customer Officer and has a very strong background in this area and she's helped us begin to think. So it's one management change on the team. But I think the biggest thing she's done, first and foremost, is to have us think about a health -- have you think about this as a health service company. I think the other thing that she has helped a great deal is to focus our energies more on the path, right, to kind of continuing to build out the enterprise along that -- those lines and really making sure, first and foremost, that's what we think about. And her ability to get us to focus is important. I told somebody the other day, the funny thing about big companies is they can launch a thousand ships because they have the capacity to do so. Wherein a small company, you don't really have that luxury, so you tend not to do that. And so focus, right, and prioritization in some ways is even more important in a large enterprise than a small enterprise just because of your ability to go in different paths. So she's brought a lot of focus, I think, on the mission ahead. And we've -- that's helped us sharpen I think the strategy over the last 6 months. And we still have work to do, but I think we're more and more pointed in the right direction and consistently pointed in the same direction.

Okay. No, those are great. Obviously, I got to take some of the high-level comments, and put it down into some numbers. On the third quarter conference call, I think the comment you made about '22 was that the $8.20 then consensus would be within the range somewhere that you'd ultimately come out with. I'm not going to ask you to rehash all the puts and takes she went through on the Q3 call. But I will ask what -- as you sit here today, what are the open questions in your mind? What are the big swing factors? I'm assuming one would be what happens with COVID and that you probably guide conservatively around that, but -- and feel free to comment on that. But what else are some of the big swing factors in your mind or open questions as you enter '22?

Yes. And I know -- I'll tell you -- I'll give you a few more, and I know it's a little bit unsatisfying, but it is COVID, right? It is the huge swing factor. And how much of the bounce back that we actually see and ultimately realize in HCB is a big issue. The level of vaccines and testing in retail is a huge issue. The ability to maintain margin on vaccine and testing in retail is a big issue as we go into next year. And these aren't -- in some ways, some of these things aren't even execution issues or they could be environmentally driven as well in terms of how long does the PHE go on and things like that. So that really is, by far and away, I think the single, biggest swing factor. Some other items, though, that as I think about what that range will ultimately look like, one will be capital deployment. We're nearing the end of a delevering period of a few years. And I think as we think forward, we'll have more flexibility about how we use that capital. And as I've talked about before, that generally will go -- you could -- you have the ongoing delevering, but you also now maybe have the potential for M&A, some modest share repurchase and maybe the dividend. So those are all things that as we finalize our thinking on 2022, I think capital deployment will be one of the things around that range. But like you said, there's the normal kind of push-pull headwinds, tailwinds that are always around these things in this business. but COVID becomes sort of the dominant factor. And maybe its cousin, which we used to obsess about, flu season is another one. We're largely assuming it's a normal -- going to be a normal flu season, but that -- again, that tends to move things around, but not -- I don't expect it to have the leverage that COVID potentially has.

Sure. Last week, the market was cheered by the news that Pfizer might have a treatment for COVID. Whether it's that or whether it's something else, if we had a magic pill that comes out and wipes out COVID on January 1, you've got moving parts where you're benefiting some from vaccines and things like that. On the other hand, you're being pressured by benefits and the health benefit. Would your outlook for '22 get better, or worse, or about the same if all of a sudden, January 1, hypothetically, COVID was completely wiped out?

Yes. And well, as we've positioned it today, right, if it really was sort of wiped out for whatever reason, right, we said that -- my commentary presumed a relatively neutral effect. So I would get, in theory, a pickup on HCB, and I'd lose something on the retail side. I think I was actually listening to somebody driving home last night, the doctors talking about even with these new antivirals that there should be a big push to get people vaccinated who aren't vaccinated because of the importance of getting those antivirals to people very early on and the ability to rapid test and identify, which heretofore has not been great. So that -- so I would think there'd still be some vaccine push through all of that. And I mean, these -- I think in commercial, I think these COVID admissions are costing us $50,000 at admissions. So a $700 course of treatment or whatever it's going to be is -- to head that off, it's probably a good trade-off -- not probably. It is a good trade-off. So if it went away in one fell swoop, the way we've thought about it, we'd probably be neutral at this point, but a lot needs to be seen about even -- there's a lot of details behind that. Like is the government going to buy those antivirals and distribute them like they're doing with the vaccine? And then how is that mechanism going to work? And so a lot -- just a lot we need to know about it.

Okay. Okay. And you talked about having capital deployment and some opportunities there. You obviously have a unique sort of set of assets and resources, pharmacy, the HealthHUBs and the MinuteClinics, the PBM, the insurance business. Where do you think there is still incremental areas for investment? Maybe even inorganic growth, it would be of interest to you as you have more capital available for that type of thing.

Yes. I'd say there's really 3 things as I think about M&A, 2 of them of which are probably more relevant in the near term. One would be, if you want to use the phrase tuck-in, you can. But I think about it in the sense of there are still certain high-growth areas, maybe it's government programs in HCB, maybe a specialty pharmacy, for example, in PSS, where more moderate-sized assets can be brought onto our platform. And with sort of the size and scale and our cost of goods sold, we can really get some accretive value. And I -- just to be clear, I'm not sure strategically nor do I think maybe even -- I don't -- I'm not thinking huge deals here when I say that about government programs, right? I'm thinking really about tuck-ins there, but things that leverage the high-growth areas of our existing business that have that. The biggest one, though, I think, for the long term in the strategy is our capabilities that help us advance what I'll call the care delivery business or the care delivery vertical. And that, I think, needs to be our focus, and we need to -- they're capability-based acquisitions. And so I think we need to be thoughtful about how we do that because, obviously, sometimes these capability-based acquisitions are not accretive and could be dilutive. And so we have to think about how to navigate that. On one hand, we need the capability, and I think it would accelerate our development to do this inorganically. But there may also be things we can do organically. But I think the capability-based M&A is the one that for the long term, that's important for us to execute on. The third one, by the way, I think, is once that begins to mature, then I think there's adjacencies, whether they be in care delivery or pharmacy or whatnot, that might make sense to continue to grow into. And if I think -- if I just stay on the care delivery track, I think the nice thing about this is 2 things. The care delivery business could -- exposes us to new revenue streams that have better growth dynamics. But the other really important part of it is it makes our other businesses, particularly HCB, even better. And that's an important part. But also once you've sort of designed and thought about what is that care delivery platform look like, it does inform you, I think, about what services make sense to continue to attach to it as you expand it over time as opposed to just thinking about the services in isolation. You begin to think about them as part of a system. And I think that's down the road as we start to flesh that out. But I'd say that's the third prong of M&A in my mind.

Okay. And I'm making sure I understand what you're talking about on care delivery, obviously, your health benefit peers are into home health or into physician practice. Is that the type of thing you're talking about? Or is there other areas that would not be as obvious that would see -- footprint would be interesting?

Well, I think there's one that's a little bit attached, but I think the core of care delivery will be what I'd call kind of next-gen or advanced primary care that we've described that before as sort of at the center and then surrounded by this very large network of physician extenders through the HealthHUBs and the MinuteClinics. So primary care, next-gen primary care in the community, that is definitely one leg. And I think there's multiple things that we might need to do to enable that virtual. And again, whether we need to rent, own, we need to have a capability, and importantly, it needs to be integrated and connected to that community resource. And in some ways, it just needs to be smooth and synchronous with everything that's happening, if people bounce back and forth between the physical and the virtual. And then the third, as you mentioned, is home. We have some home assets today, but I think we do need to think about other subacute home assets as well. So that triangle is the triangle that I believe is important for the care delivery platform. But obviously, the other big thing we do today is on pharmacy is fulfillment. And fulfillment of what comes out of that care delivery kind of triangle is also important. And we really should be and intend to be the leader in omnichannel pharmacy. And potentially, over time, there's other fulfillment assets that we could connect to that, that's probably more down the road. But I think about that core care delivery and then what kind of fulfillment assets, frankly, add to the customer experience and improve the cost, access and quality equation.

If you think about making a push into those care delivery areas, I mean, your MinuteClinic, HealthHUBs is under the retail division. You've got some potentially under the health benefits. Would be -- do you set up a fourth division to go after this as it gets to critical mass? Or where does this all fall out in terms of the reporting structure?

Yes. And obviously, we have not made any final decisions, but -- and Karen and I and the management team have had a lot of discussions about this. And the words I use, right, which is about building a new care delivery business, that is not necessarily a kind of save retail strategy or save this -- it's about putting -- standing up a payer-agnostic care delivery business. And so I think, logically, it might make sense to organize along the way that you described. But that's still a lot we have to work out, and as part of it, what assets would go in there and what wouldn't and how would it relate to HCB and retail. And those are the things, but ultimately, and I tell Karen this all the time, the way we should organize ourselves is the way that optimizes our chances for successful execution, and that's what we should do.

Right, right. I see somebody's e-mailing me to your question about orientation or tuck-in deals, and that probably makes me -- I think I should tell people if they want to e-mail me a question that I can ask on their behalf, feel free to do that at [email protected]. But this person would say, "Can you define a tuck-in? Given CVS' size, what qualifies as a tuck-in?"

Yes. I got to think about whether I would put numbers around that. But I'll just use some examples, right? Could I see us doing like single site or even like regional site MA or Medicaid? Yes, that's one I would think about on the HCB side. There's a number of smaller players in the specialty pharmacy space. We're not talking kind of billions and billions and billions of dollars here. And these are things that I think -- we have a lot to do with care delivery. And so the things that we do that aren't direct to that but still help our foundational businesses, they need to be of a size and scale that frankly don't distract from the primary mission, and they need to be able to show relatively quick value, and that's the kinds of things we would look at. So there's a number of reasons why I wouldn't really go way up the food chain and seek something out large in that space. But hopefully, that gives you a better flavor. It's always a little bit -- yes. Like I say, you need a dance partner on these things, so it's hard to predict who that will be sometimes. So...

Right. No, I understand. What -- on the primary care and the physician, you have had very good growth over the years -- last few years in the MA book. And the 2 biggest players talk a lot about their shared risk arrangements with the physicians. You don't have a lot of in-house physicians at this point, but my understanding is you're still contract with a fair some with the Oak Streets of the world and the other guys. How much of your MA book at this point is tied up in those kind of shared risk arrangements with the physicians? And is it growing?

Yes. I will get the exact number. It is a meaningful number in some form of value-based payment, and it has been a source of growth for us. And so yes, you're right, we have largely went down the path of a partnership model. And I think this is an important point, A.J., and it actually is somewhat related to your prior question. And if you think about 2 of our -- the 2 people ahead of us in MA, right, you know who they are, right, they have kind of what I'll call provider solutions, integrated provider solutions going forward. And I think if you -- if I just got bigger in Aetna's core business, I'm not sure strategically I have a better response to that. And so the move into care delivery, again, I think, is a good move on its own right, given the assets we have. But I actually think strategically, it's important because it's going to create an alternative answer for our existing business in terms of the partnership models that we've had to date. Inevitably, I think we will have a hybrid of things. That just tends to be the way the world and the market works. And I think as these things play out, we will continue to have partnership arrangements, but hopefully, we'll also have our own proprietary arrangements as well. But again, that system will be payer-agnostic. And anybody could, in theory, use that system much like anybody uses some of the players that you described in your question.

Okay. No, that's great. And you said that all the stuff about capital allocation is within the context of your continuing to want to drive down your leverage. I think you had stated for a while, 3x debt to EBITDA, now that includes capitalized leases and maybe some other adjustments. Since we don't -- may not have privy to all that, and there's a question about how do you capitalize leases, the different people do it in different ways, where are you at with respect to leverage today? How much of your significant cash flow from operations, I think $13 billion to $13.5 billion this year, will be devoted to paying down debt on an ongoing basis do you think to get to where you need to be and the time frame you need to be?

Yes. So we've retired a lot of debt, over $18 billion since the Aetna acquisition, $6.5 billion next year. The next 2 years, '22 and '23, we have $4 billion of debt each year that will mature. And so in many ways, right, that's the -- that's sort of the universe of what we can -- we could retire over the next couple of years. I would -- it's -- with where we are now in our guidance, I think we would end the year around $3.6 billion, $3.7 billion-ish or something like that. And -- but again -- and so I -- to be clear, I'm very committed to having what I would describe as a kind of a safely and investment-grade company here. But we are coming down to -- I could use all the capital that I get next year and pay off that $4 billion, and I'd still have some left, right? So that's the path we went down. So again, I do think the next 3 years of capital deployment for this company are going to look different than the last 3 years. And this will be about sort of maintaining and managing leverage responsibly. But frankly, first, my first use and my preferred use generally after that is to grow the business and find the capabilities. And that varies from year-to-year based on the opportunities. And my experience is that over time, a balanced deployment works best where you'd be continuing to grow your business inorganically. But you'd also be doing some modestly accretive share repurchase and maybe moving the dividend along with EPS growth as an example. So I think going forward, we're thinking more about where each pocket -- how much capital goes to sort of each pocket and how we manage the balance sheet and all of that.

Yes. And just to make sure I got the numbers right, $13 billion to $13.5 billion cash flow from operations is in your guidance this year. I think the capital spending would be about $2.7 billion to $3 billion. So you had about $10 billion of free cash flow. And then like you said, if you had $4 billion toward the debt repayments, you have $6 billion left over.

Yes. If you wanted to think about this year as a construct, what happens to that $13 billion, $13.5 billion, as you mentioned, there's a CapEx element which has generally been between $2 billion and $3 billion, maybe $2.5 billion. Our existing dividend is about $2.5 billion as well at the current levels. And then our insurance business, as it grows, we need to leave some of that cash and capital generation behind for RBC, and that can be $1 billion, $1.5 billion. It depends on the level of premium growth. But that could produce something on the order of $6 billion to $7 billion fairly easily before you think about delevering M&A and things like that.

Right. Okay. I've got a couple of e-mail questions. Why don't I give a few of these guys a chance since they're the ones who pay the bills for us. One -- someone's asking, what about divestitures, divestments? Is there anything that you -- I mean, you're not going to announce some investor today, but give us a sense of where you're sort of evaluating the portfolio, if possible, if there's anything to be said there?

Yes. No, it's a great question that I don't get asked actually often by investors, but we are going and have been and have a process to continually go through our portfolio and look at the businesses we have by -- and I think we look at, do they fit the strategy? What's the dilutive effect, if any, of selling some of these businesses? What's their salability in terms of it? And also, for some of them, to your point, about a company of this size, are they ever really going to be big enough that we should -- that, that warrants -- this a bit of it. It's a bit of a double up with strategic fit. So I think this -- these ideas are definitely what we're applying to the portfolio, and I wouldn't be surprised in the near term if we did do something in this regard. I wouldn't expect it today to be earth-shattering or anything like that, obviously. But it is a very important part about frankly how I talk about this internally. It's not only about the new stuff. It's about, again, going back to keeping our focus and calling out the things that just don't -- some of these are businesses that make sense for capabilities that we need but we just don't have to own them, for example, right? So there's a number of things like that, but it is something that's really at the top of my list as well as the acquisition side.

Right. Right. The PBM has done really well this year and frankly, last year, and you talked about the high retention rate heading into next year and some contract wins. When you specifically focus in on that, what would be the puts and takes that we should look at for that division since it's not always as transparent exactly what's happening there? I know specialty has been an important component as well as, like I said, as a general perception that CVS is on the upswing, I think, in the market in terms of its competitive positioning B2B peers. Anyway, I'll give you a chance to talk about that.

Yes. No. There are those moments that sometimes everything seems to be going right for a business, and that's a bit of what has happened here, I think, with PSS probably over the last couple of years but certainly this year. And this ultimately always starts, and although we don't always talk about it this way, with being able to produce industry-leading drug trend management. And we've done that on behalf of our clients. We've continued to do that. And to do that today requires some really specific capabilities around specialty because specialty is probably in the neighborhood of 50% of pharmacy spend today. And when you look at beyond sort of the normal cost comparisons between players, one of the things that has helped us a great deal in the marketplace is -- are some of the specialty management programs we have and, frankly, some of the customer technology and ability we have. The ability, for example, to pick up a specialty pharmacy drug at a store is something that a lot of people take advantage of and like we have a very good digital connectivity around specialty, where we can bring in medical records and find the right match for different circumstances. So it's a strong business that's executed well and has great capabilities. And to your point, if you looked at this business over a long period of time, the traditional channels of value of mail and network and things like that have begun to shift heavily towards specialty. And specialty becomes a more meaningful source of earnings and really one of the big levers that's driven growth in this business over time.

Yes. You've talked about the GPO that you guys have set up has been a nice tailwind for you. What are you doing there? It sounds like it's mostly helping CVS today, but would it be something that would be targeted to enhancing client results as well? Give us a little more of what you're doing there.

Yes. I mean, the GPO negotiates all of our commercial rebates for all of our customers and does negotiate those contracts, and they've done great in terms of creating more value for our customers in that classic rebate contracting. But there's obviously other services that we provide through that through pharma as well. And I think today, that value to the client has largely come through the ongoing successful negotiations around rebates, but we have thought -- we certainly have ideas on how we might be able to use that GPO to work with some different models in pharma on different maybe specific drugs and different value-based arrangements or different condition programs that could bring value both to us and our clients. So to the point of your question, it's been something that this year has been part of the growth story. I think it will grow next year, but it also is a platform from which we can do potentially more creative things down the road, all in the vein of, again, reducing cost.

Right, right. Pricing in the Health Care Benefits business has been a topic of discussion really since the second quarter. Some of your business, obviously, Medicare bids were in early in the year. Others, you can price later in the year. How do you see the landscape generally? How you feel about pricing given what happened with the COVID surge and then the abatement of that? Do you feel like you're priced conservatively for next year? Will we see -- or you're priced for growth? How do you see the layout compared to the competitive landscape?

Yes. So let me talk about the 2 sides of that. And in the category of sort of my how things have changed, it's important to remember that government premiums today are about 75% of the premium that is in HCB, and the vast majority of that is Medicare. And so the good news on Medicare and the good news even through Delta has been the baselines that we have assumed, going back to bid submission, they have held, and underlying utilization has looked good. And even in Delta, we saw enough deferred utilization. We still were better than expected. So that one is important and feels like it's on pretty good footing. In commercial, we -- which is obviously about 25% of the premium now, we've generally embraced the same philosophy that we've had over time around pricing discipline. And we've been watching this, and we've made more than one adjustment in pricing as we've seen kind of costs change. And this sounds a little bit like I'm talking out of both sides of my mouth, but I feel as good as you can feel in this environment about our pricing. I can't necessarily poke at anything that I think is in wrong. And I -- from what I understand the market to be, I think we're in sync and in the right place in the marketplace. So I feel okay about commercial right now. And -- but again, as you -- we started our discussion, right? The amount that -- the amount of kind of bounce back in HCB is going to be one of the big levers that drives year-to-year change in profitability. And at least heretofore, commercial has been the one that we spent a little more time on recently because of Delta. I mean, I'd just say again, coming out of the quarter, we did see a lot of -- we did see a significantly lower number of inpatient admissions, and things were definitely trending down the right way coming out of Q3. And we'll -- again, we'll see how the quarter plays out here. But by the time we got to the call, all signs were good that things were kind of going back in the right direction on that.

Okay. Okay. And have you assumed that you have a fair amount of deferred utilization that carries over into next year, would you say? Or how do you think about that?

No, I would not say that we have a lot. If you -- it's been declining generally. It's every quarter. And as we thought about the rest of the year, we thought that we would have deferred utilization in Q4 but probably half the level that we just saw in Q3. And eventually, we would see that kind of beginning to approach 0 sometime in probably the first half of next year. And honestly, I mean, the further we get away from 2019, just you have to ask yourself whether what you're seeing is deferred utilization or just the way things are going to be.

Right. And just 2 other quick questions here, I guess, and we wind down. On the script growth assumptions, I think you're looking at 5% in 2022. Is that -- I mean, there's a lot of moving parts there. I assume there's a modest benefit from vaccines and all in there or -- but also, a lot of the other things you're doing is designed to drive foot traffic. How much is that, the market? And how much is that other things that are specific to CVS that you're looking at?

Yes. I mean, there are things we've done every year, I think, to try to drive script volume. I mean, script volume is an important way we've tried to soften some of the push on the reimbursement issue in pharmacy. So next year, I think we're expecting on the vaccine and testing side, 30% to 40% of the volume of this year. I don't know if we've given out a '22 number for script growth, but to your point, it's been in the neighborhood of 4% to 5% without COVID. And I don't -- we certainly don't -- I don't have atypical kind of assumption out there for '22 in my mind. So -- but there always is a lot of activity. And again, we've -- one of the smaller levers is how much of the pickup we've seen, frankly, in both front of the store and a little bit on the pharmacy side this year, how much of that persists and carries into next year.

And one of the things the company has talked about at a high level is just sort of looking at the footprint of the retail stores. Any sense about where we're at today in terms of how many stores and what that might look like 3 or 4 years down the road? Is it mainly redeploying places today to better locations? Is it actually a net decline in the number of stores you'll have?

Yes. I think we are working through that, and no final decisions have been made, but I do think it's likely that there would be less stores rather than more. As I think about the future, it's more of a, what I'd call, kind of a de-densifying kind of process. Most of our stores actually are performing well, and the true number of stores that are sort of in a different position is fairly low. But when you think about optimizing the fleet and you look at some of the geographic distribution around that, I think what you would conclude is that over time, it will be less than we have today.

Yes. Yes. Maybe last, I said that's last, but anyway, what about the Investor Day that's coming up? Would you -- any preview on the Investor Day and what we should expect coming out of that?

Yes. I mean, obviously, we'll be a bit more explicit about our '22 guidance. We'd like to lay out more of the strategy and why we think it's the right thing to do, how that might manifest itself in our businesses, a lot of which we've talked about pieces of it. So I think it's our time to lay out a number of things and add some specificity to capital deployment, the strategy, the '22 guidance and just sort of have one focused discussion sort of about that and the future of the company and the trajectory that we see ourselves on over the next few years.

Okay. Well, I really appreciate CVS Health presenting at our conference this year, and specifically, Shawn, you and Susie for being a part of it. So thanks very much, and we wish you all a great Thanksgiving.

Great. Thank you, A.J.

Take care.