CVS to remain in the 'penalty box' on weak earnings, market share losses, Jefferies says

Published Mon, Dec 12 201611:22 AM EST

A Jefferies analyst on Monday rated shares of CVS Health as a hold in new coverage, predicting weak earnings in 2017 as the firm struggles with market share losses in its pharmacy business. "The company's recently-announced script and market share losses on the retail pharmacy side of its business present a meaningful revenue and earnings headwind that in our view, has reset CVS's growth outlook," equity analyst Brian Tanquilut wrote in a research note. "The company will be unable to deliver the positive earnings surprises in 2017 that are necessary to get it out of the investor penalty box." This year, shares of CVS are down 18 percent compared with a gain of nearly 11 percent for the S & P 500 index. The previous Jefferies analyst had a buy rating on the stock. Source: FactSet The analyst cited competition from Walgreens Boots Alliance (WBA) , which he rates a buy. "CVS expects to lose > 40MM scripts in 2017 (~3.8% of 2016 Rx) as a result of WBA's success in signing preferred provider agreements with TRICARE and Prime Therapeutics and 90-day retail deals with Optum & ESRX (signed ahead of CVS), which could drive market share away from CVS," Tanquilut wrote. Similarly, price wars triggered by the likes of Optum to capture market share in the pharmacy benefit management sector could reignite an overhang in earnings for CVS as early as the spring of 2017, according to Jefferies. "The PBM sector is seeing increased competitiveness as Optum has poached clients away from CVS this year and will likely pursue more contracts in spring '17. ESRX has also changed its stance on client retention, with its new CEO noting a goal of renewing 98%-99% of clients (vs. previous goal of ~95%)," Tanquilut wrote. The analyst notes that over the last nine months, CVS lost PBM contracts for Calpers, Employees Retirement System of Texas and GE to OptumRx, which is owned by UnitedHealth. Even though the loss of these three contracts is likely to be "somewhat immaterial," totaling about $2.2 billion, analysts at Jefferies say the trend has been set in motion, with the potential for CVS to lose additional clients as competitors step up their efforts to steal market share from the pharmacy retailer. Given the potential for lower earnings and market share losses, Jefferies believes valuations for CVS may not be as compelling anymore and advises clients to remain on the sidelines. "While the stock has historically traded at a slight discount to the S & P 500's PE/G ratio, our view is that CVS's reduced growth rate necessitates a re-rating of the stock's multiple that will only reverse when CVS can show improved core growth trends," Tanquilut said. In the next 12 months, Jefferies predicts shares of CVS will trade at $82, about where it currently trades.

A CVS location in New York.

Spencer Platt | Getty Images

A Jefferies analyst on Monday rated shares of CVS Health as a hold in new coverage, predicting weak earnings in 2017 as the firm struggles with market share losses in its pharmacy business.

"The company's recently-announced script and market share losses on the retail pharmacy side of its business present a meaningful revenue and earnings headwind that in our view, has reset CVS's growth outlook," equity analyst Brian Tanquilut wrote in a research note. "The company will be unable to deliver the positive earnings surprises in 2017 that are necessary to get it out of the investor penalty box."

This year, shares of CVS are down 18 percent compared with a gain of nearly 11 percent for the S&P 500 index. The previous Jefferies analyst had a buy rating on the stock.