Industry Analysis Food and staples retailing, 2nd largest segment of consumer staples industry Pros: defensive, stable growth, dependable revenue, low beta Cons: rising raw material costs, high valuations During periods of weak growth, industry tends to outperform (demand for basic products remains stable) Lawmakers considering legislation to prohibit Canadian pharmacies from selling prescription drugs to US mail-order customers Consumer preference has shifted towards cost-effective choices Baby boomers propelling growth in drugstore segment

Company Overview CVS Health Corporation is a pharmacy innovation company 9,600 retail pharmacies, 1,100 walk-in medical clinics, PBM w/ over 75 million plan members, senior pharmacy care business serving over 1 million patients per year, & specialty pharmacy services Three reportable segments: Pharmacy Services, Retail/LTC, Corporate Major competitors: Walgreens, Walmart, Express Scripts (PBM)

Basic Figures Annual dividend rate: $1.70 Annual dividend yield: 1.62% Beta: 0.96 Market capitalization: $114.8 billion 52-Week Range: $81.37-$113.65 Price as of today: 100.64 P/E: 21.9

Pharmacy Services Provides pharmacy benefit management (PBM) solutions PBM – third-party admin of prescription drug programs Essentially, lowers costs + improves health care outcome Clients: employers, insurance companies, unions, gov’t employee groups, health plans, Managed Medicaid plans, plans offered on public and private exchanges, and individuals Develop and maintain lists of drugs covered, negotiate discounts and rebates w/ drug manufacturers, and process and pay prescription drug claims Includes mail order pharmacy, specialty pharmacy, and MinuteClinic

Retail/LTC Retail Sells prescription drugs and assortment of over-the-counter and personal care products, beauty and cosmetic products, and “front store” products (general merchandise) LTC In Aug. 2015, acquired Omnicare Omnicare’s long-term care (LTC) offers ancillary services to chronic care facilities

Corporate Provides management and admin services to support overall operations of CVS Health Corporation

Recent Developments New image Focus on health care services In Feb. 2014, stopped selling tobacco products Changed name from CVS/Caremark to CVS Health Focus on health care services MinuteClinic – plan sponsored co-pay reductions → reduces emergency room visits, helps to lower overall health care costs Face-to-face patient counseling Target acquisition In Dec. 2015, acquired pharmacy and clinic businesses of Target Acquired Target’s 1,672 pharmacies across 47 states, clinic locations will be rebranded as MinuteClinic, CVS Pharmacy will be included in all new Target stores that offer pharmacy services

Hypothesis Target acquisition → higher volume → leverage in obtaining lower drug- acquisition costs Revenue growth, EPS growth, increase in net income, good cash flow, and solid return on equity outweigh low profit margins and other weaknesses/risks

Positives Revenue growth Earnings per share growth Since same Q one year prior, revenues rose by 11.0% (beating industry average of 7.7%) Earnings per share growth Since same Q one year prior, earnings per share rose by 17.5% Increase in net income Since same Q one year prior, net income increased by 13.4% (significantly exceeded that of the S&P 500 and the Food & Staples Retailing Industry)

Positives Cash flow from operations Return on equity Since same Q one year prior, cash flow increased by 4.32% (beating industry average of - 17.22%) Return on equity Since same Q one year prior, return on equity increased by 14.05% (lower than industry average of 17.97%, but higher than S&P 500 average of 12.28%

Risks Declining gross margins Reimbursement levels Compliance Competitive pressures + increased client demand for lower prices More pharmaceutical manufacturer discounts going directly to patients Reimbursement levels Increased utilization of generic pharmaceuticals (higher profit rate, decreased reimbursement payments) + consolidation within generic manufacturing industry → difficulty offsetting decreased reimbursement through negotiating lower costs Compliance Increase in gov’t regulation and audits Client losses Increased consolidation in PBM market If client acquired by non-client, may be unable to retain all or a portion of the acquired business

Risks Acquisitions Debt Litigation Weak liquidity May be unable to successfully integrate Debt May dampen incremental investments in business and limit flexibility to respond to industry changes and market conditions Litigation Retail and LTC highly litigious industries Weak liquidity Quick Ratio is 0.62, shows lack of ability to cover short-term cash needs Gross profit margin: 19.16% for Q4 FY15, 19.22% for Q4 FY14

Litigation Currently involved in various legal proceedings Securities class actions Antitrust litigation Qui tam and False Claims suits

Looking Forward Will be focusing on converting current Target customers that don’t already use the store’s pharmacy services Back-store sales better than front-store sales Continued growth in clinic business; now owns 1,135 clinics in 33 states, last Q opened 36 new MinuteClinics and added another 79 as part of Target acquisition However, CEO Larry Merlo stated that the company may not hit its goal of having 1,500 clinics by 2017, as the company will be focusing on the Target integration

Looking Forward Thomson Financial EPS estimates: $5.82 for 2016, $6.56 for 2017 CVS adjusted EPS estimate: between $5.73 and $5.88 for 2016