We are reiterating our $99 fair value estimate for CVS Health (CVS) after the wide-moat pharmacy benefit manager reported strong first-quarter results. The company reported a robust increase in revenue for all segments as its efforts to become a preferred pharmacy in restricted networks drove the retail top line and a good gain in client wins and client member growth bolstered its PBM operations. Impressively, CVS also expanded its gross and operating margins by 25 and 23 basis points, respectively. The company’s retail segment did experience a 42-basis-point decrease in gross margin as it was forced to discount its generic pharmaceutical products in order to obtain preferred pharmacy status on several PBM pharmacy networks. However, the company was able to offset this headwind with a 96-basis-point reduction in centralized costs, driving overall operating margin for the segment up 54 basis points. We believe management did a great job driving profits and recovering its top line over the quarter, but the main focus for investors moving forward will be the acquisition of Aetna (AET).
Management said the merger is on track and expected to close by the end of 2018. CVS has established an integration team, realigned its operations to make the transition easier, and issued acquisition-related bonds to lock in a low cost of debt. Aetna reported that it has also reorganized its own operations by combining all healthcare operations and selling its nonhealthcare businesses. In addition, the managed-care organization acquired 279,000 new Medicare members as it looks to build its portfolio in one of the fastest-growing and most consistent health insurance cohorts. This development falls in line with what the management teams of both CVS and Aetna said was their stated operational goal for the new healthcare services company. We believe this preparation well ahead of the transaction closing is a positive, as it should lessen any major integration issues between the two complex companies.
Vishnu Lekraj does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.