30th Annual Credit Suisse Healthcare Conference

Nov 10, 2021

Summary

Strategy is shifting toward integrated, payer-agnostic care delivery, with advanced primary care, virtual and home care among the priorities. COVID, capital deployment, and portfolio choices are key factors for 2022 and beyond.

Hi, everyone. I'm AJ Rice, the Health Care Services Analyst at Credit Suisse. We're very pleased to have up next presenting CVS. We have Shawn Guertin, Chief Financial Officer, and Susie Lisa, Senior Vice President of Investor Relations. Thank you guys for participating once again in our conference. Shawn, you joined CVS earlier this year with a few months under your belt now. What have been your major learnings to sort of open with a pretty high-level question? What have been some positive surprises? What have been any challenges that you've seen? Yeah. No, thanks, AJ, and good morning, everyone. Overall, I would say I haven't really been surprised by anything. I would say on the challenge side, a lot of the challenges certainly that I was aware of from the outside and that you all talk about that face the PBM or face pharmacy, they're quite real and they're of a significant magnitude. I would say again that maybe the size of that, when I really got in, was more eye-opening to me than I expected. But I think I also sort of saw the sort of the size and the sophistication of some of these assets as well to kind of confront those challenges. I think on the other side, I continue to be struck by, I think, how much opportunity exists going forward. As I mentioned, I think there are some very strong franchises here. The government business, in particular, the Medicare business in healthcare benefits is continuing to be a very strong franchise. The scale and sophistication of Caremark is obviously a very strong asset that we go into this with. We do have a great deal of understanding on the consumer front too. I think the other thing that I thought about on the outside, but I continue to think about as the quarters have progressed here, is when I think about the ability in fairly short order to scale up and do 44 million vaccines and 30 million COVID tests and produce revenue in excess of $3 billion this year, I acknowledge it's being fueled by extraordinary circumstances and unprecedented circumstances. On the other hand, it really kind of demonstrates to me the latent power that exists in a model that's national in scale, but locally deployed, which in many ways is the idea behind the entire enterprise. I think the other thing I remind myself of a lot is just the size and scale and capital generation ability of this business. Before we deploy that capital, throwing off $12 billion-$13 billion of free cash flow, it is significant. As we kind of wind down delevering, that becomes a very powerful tool that we have to deploy. Yeah. No, that's great. That's great. Even you're relatively new coming back to the company, but Karen took over as CEO at the beginning of the year. I think there's been quite a bit of management changes and upgrades, I guess that would be the word to use. Can you maybe walk us through a little bit of the changes she's made and that the company has seen since she's taken over and its divisional operations? Yeah, I think there's a number of things. One of them, though, that is, I think, philosophical that has governed a lot of it is her reorienting the company and the management team to think about ourselves as a health solutions company or even a health services company broadly, as opposed to just a retail or a pharmacy-specific company, and changing that transformational in terms of how we just think about our mission. A company, though, that will have a keen focus on consumer. To your point, she brought in a woman named Michelle Peluso, who is not only helping us with digital marketing, but is our Chief Customer Officer and has a very strong background in this area. She's helped us begin to think. It's one management change on the team, but I think the biggest thing she's done first and foremost is to have you think about this as a health service company. I think the other thing that she has helped a great deal is to focus our energies more on the path, right, to kind of continuing to build out the enterprise along those lines and really making sure first and foremost, that's what we think about. Her ability to get us to focus is important. I told somebody the other day, the funny thing about big companies is they can launch a thousand ships because they have the capacity to do so. Where in a small company, you don't have that luxury, so you tend not to do that. Focus, right, and prioritization in some ways is even more important in a large enterprise than a small enterprise just because of your ability to go in different paths. She's brought a lot of focus, I think, on the mission ahead, and that's helped us sharpen, I think, the strategy over the last six months. We still have work to do, but I think we're more and more pointed in the right direction and consistently pointed in the same direction. Okay. No, those are great. Obviously, I got to take some of the high-level comments and put it down into some numbers. On the third quarter conference call, I think the comment you made about 2022 was that the $8.20 then consensus would be within the range somewhere that you'd ultimately come out with. I'm not going to ask you to rehash all the puts and takes you went through on the Q3 call, but I will ask, as you sit here today, what are the open questions in your mind? What are the big swing factors? I'm assuming one would be what happens with COVID, and that you probably guide conservatively around that, and feel free to comment on that. What else are some of the big swing factors in your mind or open questions as you enter 2022? Yeah. I know I'll give you a few more, and I know it's a little bit unsatisfying, but it is COVID, right? It is the huge swing factor. How much of the bounce back that we actually see and ultimately realize in HCB is a big issue. The level of vaccines and testing in retail is a huge issue. The ability to maintain margin on vaccine and testing in retail is a big issue as we go into next year. In some ways, some of these things aren't even execution issues, or they could be environmentally driven as well in terms of how long does the PHE go on and things like that. So, that really is by far and away, I think, the single biggest swing factor. Some other items, though, that as I think about what that range will ultimately look like, one will be capital deployment. We're nearing the end of a delevering period of a few years, and I think as we think forward, we'll have more flexibility about how we use that capital. As I've talked about before, that generally will go, you have the ongoing delevering, but you also now maybe have the potential for M&A, some modest share repurchase, and maybe the dividend. So, those are all things that as we finalize our thinking on 2022, I think capital deployment will be one of the things around that range. Then, like you said, there's the normal kind of push-pull, headwinds, tailwinds that are always around these things in this business, but COVID becomes sort of the dominant factor. Maybe its cousin, which we used to obsess about flu season, is another one. We're largely assuming it's going to be a normal flu season, but again, that tends to move things around, but I don't expect it to have the leverage that COVID potentially has. Sure. Last week, the market was cheered by the news that Pfizer might have a treatment for COVID. Whether it is that or whether it is something else, if we had a magic pill that comes out and wipes out COVID on January 1, you have moving parts where you are benefiting some from vaccines and things like that. On the other hand, you are being pressured by benefits and the health benefit. Would your outlook for 2022 get better or worse or about the same if all of a sudden January 1, hypothetically, COVID was completely wiped out? Yeah. As we have positioned it today, right, if it really was sort of wiped out for whatever reason, right, we have said my commentary presumes a relatively neutral effect. Right I would get, in theory, a pickup on HCB, and I would lose something on the retail side. I think I was actually listening to somebody driving home last night, a doctor talking about even with these new antivirals, that there still should be a big push to get people vaccinated who are not vaccinated because of the importance of getting those antivirals to people very early on and the ability to rapid test and identify, which heretofore has not been great. I would think there would still be some vaccine push through all of that. I think in commercial, I think these COVID admissions are costing us $50,000 at admission, so a $700 course of treatment or whatever it is going to be is to head that off, it is probably a good trade-off. Right. Not probably, it is a good trade-off. If it went away in one fell swoop, the way we have thought about it, we would probably be neutral at this point, but a lot needs to be seen about even. There are a lot of details behind that, like is the government going to buy those antivirals and distribute them like they are doing with the vaccine? How is that mechanism going to work? Just a lot we need to know about it. Okay. You talked about having capital deployment and some opportunities there. You obviously have a unique sort of set of assets and resources, pharmacy, the HealthHUBs and the MinuteClinics, the PBM, the insurance business. Where do you think there is still incremental areas for investment, maybe even inorganic growth that would be of interest to you as you have more capital available for that type of thing? Yeah, I'd say there's really three things as I think about M&A, two of them of which are probably more relevant in the near term. One would be, if you want to use the phrase tuck-in, you can, but I think about it in the sense of there are still certain high-growth areas, maybe it's government programs in HCB, maybe it's specialty pharmacy, for example, in PSS. Where more moderate-sized assets can be brought onto our platform, and with sort of the size and scale and our cost of goods sold, we can really get some accretive value. Just to be clear, I'm not sure strategically, nor do I think maybe even I'm not thinking huge deals here when I say that about government programs, right? I'm thinking really about tuck-ins there. But things that leverage the high-growth areas of our existing business that have that. The biggest one, though, I think for the long term and the strategy, is our capabilities that help us advance what I'll call the care delivery business or the care delivery vertical. That, I think, needs to be our focus, and we need to They're capability-based acquisitions. So, I think we need to be thoughtful about how we do that, because obviously, sometimes these capability-based acquisitions are not accretive and could be dilutive. So, we have to think about how to navigate that. On one hand, we need the capability, and I think it would accelerate our development to do this inorganically. But there may also be things we can do organically. But I think the capability-based M&A is the one that, for the long term, that's important for us to execute on. The third one, by the way, I think is once that begins to mature, then I think there's adjacencies, whether they be in care delivery or pharmacy or whatnot, that might make sense to continue to grow into. If I just stay on the care delivery track, I think the nice thing about this is two things. The care delivery business exposes us to new revenue streams that have better growth dynamics, but the other really important part of it is it makes our other businesses, particularly HCB, even better. That's an important part. But also, once you've sort of designed and thought about what does that care delivery platform look like, it does inform you, I think, about what services make sense to continue to attach to it as you expand it over time. As opposed to just thinking about the services in isolation, you begin to think about them as part of a system. I think that's down the road as we start to flesh that out, but I'd say that's the third prong of M&A in my mind. Okay. Making sure I understand what you're talking about on care delivery, obviously, your health benefit peers are into home health or into physician practice. Is that the type of thing you're talking about, or is there other areas that would not be as obvious that would seem- I think- to incorporate would be interesting? Well, I think there's one that's a little bit attached, but I think the core of care delivery will be what I call kind of next-gen or advanced primary care. Right. That we've described that before as sort of at the center and then surrounded by this very large network of physician extenders through the HealthHUBs and the MinuteClinics. Primary care, next-gen primary care in the community, that is definitely one leg, and I think there's multiple things that we might need to do to enable that. Virtual, and again, whether we need to rent, own, we need to have a capability, and importantly, it needs to be integrated and connected to that community resource. In some ways, it just needs to be smooth and synchronous with everything that's happening if people bounce back and forth between the physical and the virtual. Then the third, as you mentioned, is home. We have some home assets today, but I think we do need to think about other subacute home assets as well. That triangle is the triangle that I believe is important for the care delivery platform. Obviously, the other big thing we do today is on pharmacy, is fulfillment. Right. Fulfillment of what comes out of that care delivery kind of triangle is also important. We really should be and intend to be the leader in omnichannel pharmacy. Potentially over time, there's other fulfillment assets that we could connect to that. That's probably more down the road. But I think about that core care delivery and then what kind of fulfillment assets, frankly, add to the customer experience and improve the cost, access, and quality equation. As you think about making a push into those care delivery areas, I mean, your MinuteClinic HealthHUBs is under the retail division. You've got some potentially under the health benefits. Would you set up a fourth division to go after this as it gets to critical mass, or where does this all fall out in terms of the reporting structure? Yeah, we have not made any final decisions. Karen and I and the management team have had a lot of discussions about this. The words I use, which is about building a new care delivery business, that is not necessarily a kind of save retail strategy or save this. It's about standing up a payer-agnostic care delivery business. I think logically, it might make sense to organize along the way that you described. That's still a lot we have to work out. It's part of this, what assets would go in there and what wouldn't, and how would it relate to HCB and retail? Those are the things. Ultimately, and I tell Karen this all the time, the way we should organize ourselves is the way that optimizes our chances for successful execution. Right. That's what we should do. Right. I see somebody's emailing me to your question about transformational or tuck-in deals, and that probably makes me think I should tell people if they want to email me a question that I can ask on their behalf. Feel free to do that at aj.rice@credit-suisse.com, S-U-I-S-S-E, .com. This person was saying, "Can you define tuck-in given CVS's size? What qualifies as a tuck-in? Yeah. I have to think about whether I would put numbers around that, but I will just use some examples. Could I see us doing single site or even regional site, MA or Medicaid? Yeah, that is one I would think about on the HCB side. There is a number of smaller players in the specialty pharmacy space. We are not talking kind of billions and billions and billions of dollars here. These are things that I think we have a lot to do with care delivery. The things that we do that are not direct to that but still help our foundational businesses, they need to be of a size and scale that frankly do not distract from the primary mission, and they need to be able to show relatively quick value, and that is the kinds of things we would look at. There is a number of reasons why I would not really go way up the food chain and seek something out large in that space. Hopefully that gives you a better flavor. It is always a little bit, like I say, you need a dance partner on these things, so it is hard to predict who that will be sometimes. Right. No, I understand. On the primary care and the physician, you have had very good growth over the years, last few years in the MA book, and the two biggest players talk a lot about their shared risk arrangements with the physicians. You do not have a lot of in-house physicians at this point, but my understanding is you still contract with some, with the Oak Streets of the world and the other guys. How much of your MA book at this point is tied up in those kind of shared risk arrangements with the physicians, and is it growing? Yeah. I will get the exact number. It is a meaningful number in some form of value-based payment, and it has been a source of growth for us. Yes, you are right. We have largely went down the path of a partnership model. I think this is an important point, AJ, and it actually is somewhat related to your prior question. If you think about the two people ahead of us in MA, you know who they are, right? They have kind of what I will call provider solutions, integrated provider solutions going forward. I think if I just got bigger in Aetna's core business, I am not sure strategically I have a better response to that. The move into care delivery, again, I think is a good move on its own right, given the assets we have, but I actually think strategically it's important because it's going to create an alternative answer for our existing business in terms of the partnership models that we've had to date. Inevitably, I think we will have a hybrid of things. That just tends to be the way the world and the market works. I think as these things play out, we will continue to have partnership arrangements, but hopefully we'll also have our own proprietary arrangements as well. But again, that system will be payer-agnostic, and anybody could, in theory, use that system much like anybody uses some of the players that you described in your question. Okay. No, that's great. You said that all this stuff about capital allocation is within the context of your continuing to want to drive down your leverage. I think you had stated for a while 3x debt to EBITDA. Now, that includes capitalized leases and maybe some other adjustments. Since we may not have privy to all that, and there's a question about how do you capitalize leases, different people do it in different ways. Where are you at with respect to leverage today? How much of your significant cash flow from operations, I think $13 billion to $13.5 billion this year, will be devoted to paying down debt on an ongoing basis, do you think, to get to where you need to be in the timeframe you need to be? Yeah. We've retired a lot of debt, over $18 billion since the Aetna acquisition, $6.5 billion next year. The next two years, 2022 and 2023, we have $4 billion of debt each year that will mature. In many ways, right, that's sort of the universe of what we could retire over the next couple of years. With where we are now and our guidance, I think we would end the year around 3.6, 3.7-ish or something like that. I can be clear, I am very committed to having what I would describe as a kind of a safely and investment-grade company here. But we are coming down to I could use all the capital that I get next year and pay off that $4 billion, and I'd still have some left. Right. Right? If that's the path we went down. Again, I do think the next three years of capital deployment for this company are going to look different than the last three years. This will be about sort of maintaining and managing leverage responsibly. But frankly, my first use and my preferred use generally after that is to grow the business. Right and find the capabilities. That varies from year to year based on the opportunities. My experience is that over time, a balanced deployment works best, where you'd be continuing to grow your business inorganically, but you'd also be doing some modestly accretive share repurchase and maybe moving the dividend along with EPS growth, as an example. I think going forward, we're thinking more about where each pocket, how much capital goes to sort of each pocket and how we manage the balance sheet and all of that. Yep. Just to make sure I got the numbers right, $13 billion-$13.5 billion cash flow from operations is in your guidance this year. I think the capital spending would be about $2.7 billion-$3 billion, so you get about $10 billion of free cash flow. Then, like you said, if you did $4 billion toward the debt repayments- Yeah that's $6 billion left over. Yeah. If you wanted to think about this year as a construct, what happens to that $13 billion, $13.5 billion, as you mentioned, there's a CapEx element, which has generally been between $2 billion and $3 billion, maybe $2.5 billion. Our existing dividend is about $2.5 billion as well at the current levels. Then our insurance business, as it grows, we need to leave some of that cash and capital generation behind for RBC. Right. That can be a billion and a half. It depends on the level of premium growth. That could produce something on the order of $6 billion-$7 billion fairly easily before you think about delevering M&A and things like that. Right. Okay. I have a couple email questions. Why do I give a few of these guys a chance, since they are the ones who pay the bills for us. One someone is asking, "What about divestitures, divestments? Is there anything that you I mean, you are not going to announce a divestiture today, but give us a sense of where you are evaluating the portfolio if possible, if there is anything to be said there. Yeah. No, it is a great question that I do not get asked actually often by investors. We are going and have been, and have a process to continually go through our portfolio and look at the businesses we have. I think we look at, do they fit the strategy? What is the dilutive effect, if any, of selling some of these businesses? What is their saleability in terms of it? Also, for some of them, to your point about a company of this size, are they ever really going to be big enough that we should That warrant it? This is a bit of a double up with strategic fit. I think these ideas are definitely what we are applying to the portfolio, and I would not be surprised in the near term if we did do something in this regard. I would not expect it today to be earth-shattering or anything like that, obviously. It is a very important part about, frankly, how I talk about this internally. It is not only about the new stuff. It is about, again, going back to keeping our focus and culling out the things that just do not Some of these are businesses that make sense for capabilities that we need, but we just do not have to own them, for example. Right. Right? There's a number of things like that, but it is something that's really at the top of my list as well as the acquisition side. Right. Right. The PBM has done really well this year and, frankly, last year, and you talk about the high retention rate heading into next year and some contract wins. When you specifically focus in on that, what would be the puts and takes that we should look at for that division since it's not always as transparent exactly what's happening there? I know specialty's been an important component as well as, like I said, there's a general perception that CVS is on the upswing, I think, in the market in terms of its competitive positioning vis-à-vis peers. Anyway, I'll give you a chance to talk about that. Yeah. There are those moments that sometimes everything seems to be going right for a business, and that's a bit of what has happened here, I think, with PSS probably over the last couple years, but certainly this year. This ultimately always starts, and although we don't always talk about it this way, with being able to produce industry-leading drug trend management. We've done that on behalf of our clients. We've continued to do that. To do that today requires some really specific capabilities around specialty, because specialty's probably in the neighborhood of 50% of pharmacy spend today. When you look at beyond sort of the normal cost comparisons between players, one of the things that has helped us a great deal in the marketplace are some of the specialty management programs we have, and frankly, some of the customer technology and ability we have. The ability, for example, to pick up a specialty pharmacy drug at a store is something that a lot of people take advantage of. We have a very good digital connectivity around specialty where we can bring in medical records and find the right match for different circumstances. So, it's a strong business that's executed well and has great capabilities. To your point, if you looked at this business over a long period of time, the traditional channels of value, of mail and network and things like that, have begun to shift heavily towards specialty. Specialty becomes a more meaningful source of earnings, and really, one of the big levers that's driven growth in this business over time. Yep. You've talked about the GPO that you guys have set up as has been a nice tailwind for you. What are you doing there? It sounds like it's mostly helping CVS today, but would it be something that would be targeted to enhancing client results as well? Give us a little more of what you're doing there. Yeah. I mean, the GPO negotiates all of our commercial rebates for all of our customers and negotiates those contracts, and they've done great in terms of creating more value for our customers in that classic rebate contracting. But there's obviously other services that we provide through that, through pharma as well. I think today, that value to the client has largely come through the ongoing successful negotiations around rebates. But we have thought, we certainly have ideas on how we might be able to use that GPO to work with some different models in pharma on different, maybe specific drugs and different value-based arrangements or different condition programs that could bring value both to us and our clients. So, to the point of your question, it's been something that this year has been part of the growth story. I think it'll grow next year, but it also is a platform from which we can do potentially more creative things down the road, all in the vein of, again, reducing cost. Right. Pricing in the healthcare benefits business has been a topic of discussion really since the second quarter. Some of your business, obviously Medicare bids were in early in the year, others you can price later in the year. How do you see the landscape generally? How you feel about pricing given what happened with the COVID surge and any abatement of that? Do you feel like you've priced conservatively for next year? Will we see, or you price for growth? How do you see the layout compared to the competitive landscape? Yeah. Let me talk about the two sides of that. In the category of my how things have changed, it is important to remember that government premiums today are about 75% of the premium that is in HCB, and the vast majority of that is Medicare. Since the good news on Medicare and the good news even through Delta has been the baselines that we have assumed going back to bid submission, they have held, and underlying utilization has looked good. Even in Delta, we saw enough deferred utilization, we still were better than expected. So, that one is important and feels like it is on pretty good footing. In commercial, which is obviously about 25% of the premium now, we have generally embraced the same philosophy that we have had over time around pricing discipline, and we have been watching this, and we have made more than one adjustment in pricing as we have seen costs change. This sounds a little bit like I am talking out of both sides of my mouth, but I feel as good as you can feel in this environment about our pricing. I cannot necessarily poke at anything that I think is in wrong. From what I understand the market to be, I think we are in sync and in the right place in the marketplace. So, I feel okay about commercial right now. But again, as we started our discussion, the amount of kind of bounce back in HCB is going to be one of the big levers that drives year-to-year change in profitability. At least heretofore, commercial has been the one that we have spent a little more time on recently because of Delta. I just say again, coming out of the quarter, we did see a lot of We did see a significantly lower number of inpatient admissions, and things were definitely trending down the right way coming out of Q3. Again, we will see how the quarter plays out here. But by the time we got to the call, all signs were good that things were kind of going back in the right direction on that. Okay. Have you assumed that you have a fair amount of deferred utilization that carries over into next year, would you say? Or how do you- No, I would not say that we have a lot. It has been declining generally every quarter. As we have thought about the rest of the year, we have thought that we would have deferred utilization in Q4, but probably half the level that we just saw in Q3. Eventually, we would see that kind of beginning to approach zero sometime in probably the first half of next year. Okay. Honestly, the farther we get away from 2019, you have to ask yourself whether what you are seeing is deferred utilization or just the way things are going to be. Right. Just two other quick questions here, I guess, as we wind down. On the script growth assumptions, I think you are looking at 5% in 2022. I mean, there is a lot of moving parts there. I assume there is a modest benefit from vaccines and all in that. Also, a lot of the other things you are doing are designed to drive foot traffic. How much is that the market, and how much is that other things that are specific to CVS that you are looking at? Yeah, I mean, there are things we have done every year, I think, to try to drive script volume. I mean, script volume is an important way we have tried to soften some of the push on the reimbursement issue in pharmacy. Next year, I think we are expecting on the vaccine and testing side, 30%-40% of the volume of this year. I do not know if we have given out a 2022 number for script growth, but, to your point, it has been in the neighborhood of 4%-5% without COVID. We certainly do not have an atypical kind of assumption out there for 2022 in my mind. There always is a lot of activity. One of the smaller levers is how much of the pickup we've seen, frankly, in both front of the store and a little bit on the pharmacy side this year, how much of that persists and carries into next year. Then one of the things the company's talked about at a high level is just sort of looking at the footprint of the retail stores. Any sense about where we're at today in terms of how many stores and what that might look like three or four years down the road? Is it mainly redeploying places today to better locations? Is it actually a net decline in the number of stores you'll have? Yeah, I think we are working through that, and no final decisions have been made. But I do think it's likely that there would be less stores rather than more. As I think about the future, it's more of a, what I call, kind of a de-densifying kind of process. Most of our stores actually are performing well. The true number of stores that are sort of in a different position is fairly low. But when you think about optimizing the fleet and you look at some of the geographic distribution around that, I think what you would conclude is that over time, it will be less than we have today. Yep. Maybe last, I said the last would be last, but anyway, what about the investor day that's coming up? Any preview on the investor day and what we should expect coming out of that? No, I mean, obviously, we'll be a bit more explicit about our 2022 guidance. We'd like to lay out more the strategy and why we think it's the right thing to do, how that might manifest itself in our businesses, a lot of which we've talked about pieces of it. I think it's our time to lay out a number of things and add some specificity to capital deployment, the strategy, the 2022 guidance, and just sort of have one focused discussion sort of about that and the future of the company and the trajectory that we see ourselves on over the next few years. Okay. Well, I really appreciate CVS Health presenting at our conference this year, and specifically, Shawn, you and Susie being a part of it. Thanks very much, and we wish you all a great Thanksgiving. Great. Thank you, AJ. Take care.