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CVS accident “abandoned” by insurance giants, how much impact? (NYSE:CVS)
On August 17, 2023, the share price of Blue Shield of California, one of the largest health insurers in California, said it would no longer use the CVS Caremark division as its primary drug benefit administration (PBM), and the share price of the NYSE: CVS fell about 8.5% on that day.
Prior to that, CVS Caremark was the highest market share of PBM in 2022, accounting for 33%.
How much impact does this have on CVS? This article will take you further to analyze the opportunities and risks of CVS stock.
What is the relationship between Blue Shield Insurance and CVS?
First, let's take a look at what this California Blue Shield Insurance Company is?
Blue Shield California Insurance is a non-profit health insurance company with 4.8 million members, CVS Health has been a pharmacy partner with Blue Shield Insurance for over 15 years.
In simple terms, the goal of giving up CVS Caremark aims to save costs.
California Blue Shield Insurance spends more than $3 billion on its membership prescription in 2022, and its CEO says that compared to Caremark, cooperating with 5 industry upstart pharmacies, such as Mark Cuban and Amazon, is expected to save $500 million a year in drug costs. The change will take effect in 2024, when the California Blue Shield Insurance Company and CVS contracts signed since 2021 will also end.
It is worth noting that Blue Shield does not completely give up CVS Caremark, the company will continue to use Caremark special effects to provide prescription and services for patients with complex conditions, and this part of CVS is the most profitable part of the Blue Shield insurance company.
Analysts at Evercore ISI estimate that CVS Caremark special drugs account for about 50% of Blue Shield insurance company pharmacy costs, profit remains substantial; but at the same time, the loss of part of the PBM contract will result in a decrease of CVS earnings per share by 2 to 6 cents in 2025.
The market expects that the potential impact for CVS may be far less than that.
Cost Plus Drugs will be responsible for the generic drug business, and Amazon will be responsible for the mail order business, according to a new arrangement from California Blue Shield Insurance. Puerto Rico-based Abarca Health will manage claims and Prime Therapeutics will handle drug pricing negotiations. Blue Shield's initiative is to “test” its ability to build an alternative supply chain.
This “new experiment” once announced the market relish its feasibility. “We suspect that this approach is too complicated and unpractical, but it deserves attention,” Bloomberg data analysts said. If Blue Shield Company succeeds, it may cause other companies to follow suit, thereby exacerbating industry volatility.
Where will the PBM business go?
For more detailed analysis of CVS business composition and definition of PBM business can be found in our first CVS Opportunity Mining articleOpportunity: Syvis Health CVS Health (NYSE:CVS)
The market has a two-party voice for the future development of the PBM business, the main business income of CVS.
Some believe that CVS may face the challenge of “increasing PBM business uncertainty.”
According to Morningstar, about 37% of CVS's operating profit in 2022 came from its largest business PBM, followed by retail stores (33%) and health insurance business (30%). The PBM business, which is the largest source of profit, ushered in the churn of its major customers, is a big hit for CVS.
Over the past decade or so, the three PBMs (CVS, Cigna CI and UnitedHealth UNH) have been consolidating power. The Blue Shield company's initiatives, with “retreat me in” to describe the mood of CVS competitors, because the other two gangs in the PBM field, Cigna and UnitedHealth are not directly affected by the development of Blue Shield Insurance Company in California.
The old competitors have not been weakened, and in recent years have produced such as Amazon AMZN upstart, which also said they “want to subvert the PBM industry to help reduce drug prices in the United States.” This is not a headache for these PBM giants. As this may be a sign of the beginning of change, the future of the PBM's competitive landscape may change.
According to reports, Blue Shield estimates that the transformation of PBM can help it save 10-15% on drug costs. If this reduction is achieved and these new PBMs gain more customers, the profitability of the industry could be undermined. For CVS, a rugged moat can be problematic, which is why the market reacts so much to the news.
Evercore ISI also expressed a similar opinion: leveraging the services of several new companies to deliver drug benefits can be challenging, but if the regional health insurer is successful, others may follow suit. This means that the CVS business of one of the PBM giants can have long term uncertainty.
Although there are many negative sentiments on the market for the future of CVS, J.P. Morgan analyst Lisa Gill believes Blue Shield's initiatives may not be as serious as the market reaction c for two reasons:
CVS has a clear advantage in specific drugs
Jill believes that although generic drugs have a large expenditure, but usually only accounts for 15% of Blue Shield drug expenditure. In contrast, Blue Shield's biggest drug spending part is CVS specific drugs, and this part of the cost continues to rise. One of the new channels of Blue Shield Company Cost Plus has more than 1000 generics, but almost no special effects. As a result, the company's retention of CVS specific drugs actually highlights the value of traditional PBM business and the limitations of new supply chains. Health economist Craig Garthwaite believes that CVS was able to preserve the fact that CVS was able to preserve the drug business, supporting the view that “the three PBM giants are not monopolized capitalist, but are actually doing what is important to people.” At the same time, he's willing to bet that the final savings of the California Blue Shield won't actually reach $500 million. Goldman Sachs analysts give a similar opinion: “Historically, the value of the size offered by the three major PBMs is difficult to replicate.”
Amazon accounts for a small proportion of mail order delivery business
The market is worried that Amazon, this big company will squeeze CVS business, for this, Jill think not to worry. As mentioned earlier, in Blue Shield's new supply chain, Cost Plus drugs are delivered to Amazon mail order. We look at Cost Plus's page that only special drugs can be delivered by mail order, however, Cost Plus has almost no special effects. In addition, Jill said that despite the surge in mail order prescriptions during the epidemic, mail order prescriptions have not replaced in-person drug pick-up. So in summary, Amazon's share in the new supply chain can be almost no worries.
Opportunities and risks reflected in CVS share price
According to Morningstar and Nasdaq, opportunities come from three aspects:
Current CVS stocks, like most MCO (Managed Healthcare Organization) stocks, are still in a heavily undervalued region.
As the integral nature of CVS drugs is mostly irrelevant to consumers' disposable income, CVS is not cyclical and still able to maintain high revenue growth during the current macroeconomic situation.
CVS share repurchases may push up adjusted earnings per share in the next five years, bringing it to a mid-single digits growth during this period.
Morningstar analysts believe that the risk points of CVS in the next two years are three aspects:
CVS failed to bid for a $35 billion PBM contract in 2024, with potential losses increasing the uncertainty of the overall PBM business.
The company postponed its plan to achieve double-digit earnings growth per share, with significant growth barriers facing the Medicare Advantage division between 2024 and 2025.
The new competitive power of PBM mentioned in the latest Blue Shield company announcement brings some long-term uncertainty to CVS's top position, which also depresses Morningstar's long-term profit growth assumptions for CVS.
