When CVS Health (CVS +3.65%) reported its second-quarter results in August, there were two main stories -- one good, and one not so good. The good news stemmed from its pharmacy services segment, which consists of the CVS Caremark pharmacy benefits management (PBM) unit along with several other businesses. Results from CVS Health's retail/long-term care (LTC) segment, though, were lackluster.
Will it be the same two stories when CVS Health provides a third-quarter update on Nov. 6? Here are three things you'll want to closely watch.
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1. Impact of continued headwinds for retail/LTC
Although CVS Health combines its retail pharmacy operations and its Omnicare LTC pharmacy services unit into one segment, the two businesses face different challenges. For the retail side, the biggest headwind in the third quarter will be what the company has dealt with all year long: the loss of two major contracts. This loss hurts CVS Health's prescription volumes (and associated revenue). It also negatively impacts store traffic, which weighs down front-store sales comparisons against the prior-year period.
That's not the only problem for CVS Health's retail business, though. Lower reimbursement rates also push profit margin lower. That's offset to some degree by higher generic dispensing rates, which help boost profits, but result in lower revenue. As with the lingering effects of the lost contracts, don't expect any big improvement for CVS Health in the third quarter with reimbursement pressure.
Omnicare's issues aren't likely to diminish yet, either. CVS Health bought the LTC pharmacy services leader in 2015, but the deal hasn't been a big winner so far. According to Larry Merlo, CVS Health CEO, the need to invest in technology with Omnicare and dynamics in the skilled nursing market, especially lower lengths of stay and occupancy rates, have caused progress to be slower than expected. Again, there's no reason to think the third quarter will be significantly better than last quarter. That being said, any pleasant surprises -- even if small -- could help CVS Health beat expectations.
2. Pressure on PBM profits
While CVS Health's PBM was the definite bright spot in the second quarter, one key factor is exerting pressure on profits: a decline in hepatitis C prescription fills. The company lowered its PBM operating profit margin outlook in August due to the hepatitis C slowdown.
Will weakness in hepatitis C sales still be problematic in the third quarter? Based on Gilead Sciences' (GILD 2.13%) third-quarter results, the answer is probably "yes." Gilead's hepatitis C virus (HCV) drugs Epclusa, Harvoni, and Sovaldi dominate the market. Combined sales for the drugs fell from $2.9 billion in the second quarter of 2017 to $2.2 billion in the third quarter. And that's even with a newly approved HCV drug, Vosevi, in the mix for the last quarter.
Still, though, CVS Health's PBM business should remain quite strong. Lower profitability isn't ideal, but this area will almost certainly continue to provide the best news for shareholders.
3. Medicare Part D timing
CVS Health has been clear that timing issues could impact its performance from quarter to quarter in 2017. The company enjoyed the positive side of these timing issues in the second quarter, with higher cash flow stemming from an early receipt of a Medicare Part D payment. Timing issues could be a negative in the third quarter, though.
The biggest impact will likely be related to Medicare Part D, again. The federal prescription drug program includes a risk-sharing corridor, which basically involves subsidies to plan sponsors so that they won't avoid less-profitable members who use more prescription drugs.
Sometimes, those risk-sharing corridor payments kick into high gear in the third quarter. That's what happened in 2016. This year, though, CVS Health expects a shift into the fourth quarter. If the company's projections are right, it could make its numbers artificially low when it reports third-quarter results. The good news, however, is that this is only a temporary issue.
What not to expect
So far, CVS Health hasn't made an official announcement on its reported bid to acquire Aetna (AET +0.00%). Neither has Aetna stated anything publicly regarding a potential deal. You can bet there will be plenty of questions during CVS Health's quarterly conference call about the possible acquisition. I wouldn't necessarily count on many details being provided.
However, I do think buying Aetna would be a good move for CVS Health shareholders over the long run. If Larry Merlo, or other executives, give hints that a deal is likely, it could make a larger impact on CVS Health stock's immediate movement than the third-quarter results themselves.
