CVS Health Corporation

Hi, good morning, everyone. My name is Erin Wright. I'm the lead healthcare services analyst at Morgan Stanley. Just real quickly, for more important disclosures, please see the Morgan Stanley Research Disclosure website at www.morganstanley.com. If you have any questions, please reach out to your Morgan Stanley sales representative. And with that, we're happy to have CVS Health with us this morning. With them, we have Karen Lynch, President and CEO. Thank you. As well as Sean Gerton, EVP and CFO. And then we have Larry McGrath in the audience as well. So, I will hand it over to Sean for your disclosures.

Great. Thank you. Thank you. Good morning, everyone. I just want to remind everyone today that we will be making forward-looking statements today, and you should consult our SEC filings for a description of the risks inherent in those statements as well as the risks inherent in our business and our most recently filed 10-Q and 10-K and other relevant violence.

Great. Thank you, Sean. We'll definitely get into some of the topical questions on PBMs, utilization, STARS, but I do want to talk a little bit about, Karen, the efforts to strengthen the power of the whole enterprise. With the Signify deal, Oak Street deal, it's been three months since the closure of those deals. How has it progressed relative to your expectations? Where are we at in terms of that integrated approach and your vision there? And can you talk a little bit about what synergies have materialized even thus far?

Yeah, so thanks, Erin, for that question. I do want to just take a step back and talk more about the broad strategy of the company. You mentioned it. Before we talk about the acquisitions, as you think about what we are trying to do as a company is really unlock the value and create value for the long-term earnings power of the company. And as we step back and as we looked at all of our businesses, What we said was we needed to extend into other areas for growth. And we said we needed to build out national provider capabilities, either through primary care or in the home. We said that we really needed to lead and drive value-based care. We said that we really wanted to be powered by technology so that we could make the connections for consumer experience and engagement, and that we would be in the community so that we had convenient access to healthcare. So that kind of established the strategy in which we set out, and as part of that strategy, we recently acquired Oak Street Health and Signify, as you mentioned. Oak Street Health and Signify, I would argue, are the two premier value-based care providers in Medicare today. And Signify is a home health risk assessment company that essentially is in three million homes annually and has the power to unlock return to care, has the power to unlock additional health services, and has an interlocking connection with Oak Street Health. There's value between the two businesses. As you think about Oak Street Health, Oak Street Health is a primary care, value-based provider, strong technology platform, very focused on Medicare and polychronic individuals. Again, one of the leading areas. So as you know, we closed Oak Street a few months ago, we closed Signify a few months ago, and we have been actively executing on our synergies. And what we've been doing, the first thing we've been doing is looking at opportunities across the Signify and Oak Street platforms. And so what we've done when people are in the home with Signify, they're asking, do you have a primary care physician? and we are recommending Oak Street where appropriate. When we're looking at Oak Street, we've been using our retail pharmacies to engage people when they don't have a primary care physician. Signify Health, when they're in the home, they don't have a primary care, we're recommending. We've been laying out, and the results so far, are promising and encouraging we're starting to see there's two things that matter when you think about unlocking the value of those two businesses one is membership and the second is lowering overall acquisition costs so we've been really trying to drive oak street membership and signify membership and and using kind of the whole entire enterprise to do that And as I said, the milestones that we put in place, we're starting to see overall execution on that. The other thing I would say is that we always were going to have someone to lead our health services division. And this week we announced that Sean, I'm very excited about this, that Sean will be taking over the leadership role of our health services division, which means Oak Street and Signify. will report to Sean, and he will be responsible for unlocking kind of the long-term value of revenue and earnings power of those businesses in addition to kind of other businesses as we continue to improve our capabilities around our long-term growth. So with that, Sean, let me see if there's anything you want to add to that.

Yeah, I would just reiterate what Karen is talking about. The health services strategy that we've been talking to you about is really about something to accomplish two objectives. One is to create more accretive earnings growth from year to year, but also over time to fundamentally change the growth rate inherent in this company as we build a new business that has more attractive long-term growth characteristics than the enterprise. So that's sort of the big challenge financially. The big challenge operationally is we have to run Oak Street and Signify and our existing assets to produce the synergies and create the value, and we will do that. But that's not the end of the discussion. It's about building an integrated value-based care ecosystem that provides seamless experience for our providers and our patients. that serves all payers in that capacity and is really monetized through risk bearing mechanisms. And that system is really Oak Street and Signify, but also some of our existing assets today, like the Minute Clinic and the Health Hubs, and potentially interacts a great deal with our pharmacy assets. So it's really about kind of building this long term sort of integrated enterprise that's really technology-enabled to sort of share information across the system. I've talked to many of you that this isn't just about sort of delivery silos, right? It really is about building an integrated value-based care-driven system that we can monetize through risk-based arrangements internally and externally.

Great. That's helpful. I want to start with Medicare Advantage. You have some growth expectations for the year of 12%, but can you discuss any updated expectations post the New York dynamics with that contract? What are your expectations for 2024 and how you're positioning yourself for growth? And then on STARS, I guess you were given presumably some indication in the past week or a few days or so. I guess any update there or level of insight into how STARS are tracking?

Yeah, so I'll start, and I'll start with your second question first, relative to STARS. As I mentioned consistently on every quarter, we put every effort to execute and improving our overall STARS performance. As I said on the last call, our internal indicators were improving and we were pleased with the progress that we've made. Now, obviously, there's a few more weeks until the final CMS results will go out. That is their news to tell. However, what I would say is I'm optimistic about where we will kind of land relative to our STARS performance based on the kind of internal indicators that I have. Relative to overall growth in Medicare, Medicare is an important area for us for long-term growth. It is one of the fastest-growing segments in America relative to where the growth opportunities lie. We had initially, as you said, Aaron, had thought we would have higher expectations for growth in 2023 because of the New York pandemic. win in group Medicare. However, that is being contested. But New York has said to us they are, you know, continually, you know, they are supportive of us. But you know, obviously, we'll go through through the court process with with New York. So we've lowered kind of our expectations for 2023. That was already included in our guidance for this year. Relative to 2024, we have made sure that we invested in our benefits, and we are expecting industry growth for 2024. Obviously, we don't have our competitive view yet, but we made sure that we positioned us competitively as we pushed our bids out into the market. Let me see if there's anything I missed, Sean.

No, that's right. We've set our target to get at least industry growth for 2024. But like Karen says, we really won't have a good feeling about that until we see where we stand competitively on the dynamic. It's an important growth market. I would say, because it's often confused, a lot of people think the stars issue for 2024 is going to impair growth, but the reason we have margin pressure is that we're maintaining benefits, right? So, you know, we still think getting industry growth through 2024 is a reasonable expectation.

Okay, great. That's good to hear. And then just on utilization, utilization is top of mind for investors and definitely across the entire healthcare services continuum right now. Can you give us any sort of inter-quarter indication what you are seeing? Is there... Is the elevated utilization trends that you noted in the most recent quarter, do you think that that is more prolonged than maybe what you initially thought? How should we think about what's embedded in your expectations for 2024 as well?

So that's just a reminder on expectations. We had seen a certain level of utilization pressure in the first half for 2023. We largely assumed that that would persist. for the balance of this year. And then for 2024, we carried that pressure through and added an incremental amount of pressure potentially for 2024. So that's what we had built into the expectations we shared with you on our last earnings call. I would say a couple months into the quarter, we have continued to see those pressures persist and not abate in the quarter. And it remains to be seen again how the rest of the year plays out and because we're seeing it in many of the same categories that we saw in the first half of the year, that there's nothing new there. But it is persisting at high levels. And so, you know, I would say I think in specific to our HCB business, I think it, you know, will probably be at at least the high end of our MBR guidance, I think likely a little bit higher than that. But overall, we feel very good about our guidance position for going forward. For 2023, our pharmacy service businesses continue to be strong. Our retail business is tracking well. Net investment income has continued to be a positive. So I'm comfortable with our guidance for 23, but I think inside HCB, if this continues to persist again at the level we've seen for the first two months, we'd probably have some pressure on our MBR guidance. Again, in the context of this, I wanted to be important to realize we did also assume not only this pressure, but some incremental pressure for 2024 in our outlook. And, you know, we feel that two months, that's still intact.

And what would you attribute it mostly to? Is it the pent-up demand? Is it the hips to the knees?

It looks like that, right? It's those kinds of categories, what I'd say somewhere discretionary deferrable. And so we're continuing to see it in those categories. And so to your point, I think it's reasonable to think at some point this bubble, if you wanna call it that, will abate. We're not seeing that through two months, but we're not also seeing anything different in the underlying utilization data and categories that makes us feel differently than we did a couple months ago about what this appears to be.

Yeah, the other place that we've seen utilization is in behavioral. That kind of continues to be an area of pressure across our entire portfolio as well.

I do want to ask on some of the recent dynamics with the PBM. Our view is that the reaction to the Blue Shield contract in California was somewhat overblown. But we'd be interested to hear your thoughts on the contract transition, thoughts on just broader unbundling, and will we see others follow suit, and your view on that.

Well, thank you for saying that, because I agree with you. I think it was overblown as well. I think people thought the Blue Shield contract is disruptive. What I would say is it really is just an unbundling of PBMs. services and you know as a company we continue to offer on bundle services as well you know one of the things that you know if you think about what's happening in the pbm industry obviously you know what do we do we do trend management we have you know pay claims we do service we provide specialty services and one of the highest trend areas is specialty blue shield is continuing to engage with us on that specialty, those specialty services. So, you know, that's where, you know, kind of the value from that business is coming from. I'd remind everyone that, you know, this was a large contract and a large contract. You know, we typically see lower margins on large contracts. The other question I consistently get is, you know, the $500 million in savings that they said that they would have. Do I know what they're getting? I actually don't know. We're not, you know, earning that kind of money on that account. So, you know, I think there's some questions that are still out there, right? What's their formulary management strategy? What's their network contracting strategy? And so I also remind investors that we continue to win Blue Cross Blue Shield business as well. We won Massachusetts earlier this year. We won Tennessee. Those health plans are interested in the value of our integrated offerings and the value and the service that we provide. The one thing that we are consistently focused on is consumer experience. Our MPS scores are incredibly high on an integrated case, and that would be another question I would ask. One of the things in America, if you think about what's happening in America relative to healthcare is fragmentation and unbundling of services makes it very difficult and hard for people to access care. And that is something that we are incredibly focused on as a company to make sure that people have seamless connected experiences across the spectrum of healthcare. And I would argue that the businesses that we're creating will enhance the value of consumer experience in healthcare.

Also on the PBM front and biosimilars in particular, Cordavis is another interesting opportunity and something that was a recent development as well. Can you describe kind of the role you're playing there? What's the goal, the rationale behind it, which I think we kind of know, but can you give us a little bit of an update on your strategy on that front?

Yeah, what I would say is, you know, as you think about our role as a PBM, we have one role, and that is to reduce the overall cost of drug spend. And part of doing that is to make sure that we continue to innovate. And Cordavis is one of those innovations in healthcare that we are really driving. It is a relationship with Sandoz that is a manufacturing for biosimilars. And if you think about what's important for the biosimilar market, is to drive adoption of lower-cost drugs. So with Cordavis, what we'll be doing is we'll be introducing a biosimilar that is Humira biosimilar, which will be 80% less than the current Humira price. And what's really important, two things in biosimilars that we haven't seen yet, one is adoption. And the way you get adoption is to make sure that you have the supply. So as part of our Cordavis initiative, it's really we'll have the supply and we'll have the ability to drive adoption of the biosimilar market, and that's what we're really trying to accomplish. And let me see if there's anything, Sean, that you want to add here.

Yeah, so I think the one thing, Erin, I would add, like there's many similarities between this biosimilar phenomena and what we've gone through in generic pills and tablets, but there are some differences. And Karen was beginning to get to it. There's many things, as we thought about this space around customer preference, for example, for the device delivery, like the pen or something like that. High concentration, low concentration, citrate-free, latex-free. So there's a lot about when you think about adoption that's going to have to do with customer preference for the agent. So we spent a lot of time thinking about what would be the biosimilar that would lead to the greatest sort of adoption to drive the low cost that Karen is describing. and also somebody that could sort of make sure that we had the stable supply into the market. And so when you put all those things together, it made sense for us to sort of pursue this path and kind of get that, at the end of the day, get that benefit of cost savings for all of our customers.

And will this be a strategy even beyond Humira? Maybe that's more of a unique case study, but will this exist?

No, our intent is that this will be a strategy to support the biosimilar market and to support the biosimilar adoption of our customers. Okay, great.

And then also on the PBM side, regulatory dynamics, what are you paying attention to? I think we were discussing earlier you're heading to D.C. after this conference. What are your discussions like currently? What do you think ultimately gets passed? And how are you thinking about particularly the regulatory scrutiny across the PBM?

Yeah, so what I would say, and I'll go back to kind of, there is a lot of scrutiny of the PBM market. And I think that there's a lot of misunderstanding in what we do as a company. And as I said earlier, our objective and our goal is to reduce the total cost of drugs. And that's really what we're trying to accomplish as a business and as a company. And customers, health plans, employers depend on us to do that. And so there is a lot. So when I'm in Washington, we're in Washington, we're really trying to help the regulators and, you know, senators and congresspeople to really understand the you know, kind of what it is that we do. And there's one part of kind of education that when we go to Washington, that's what we're trying to accomplish is really educating them on what it is that we do as a business and a company and how we've been continually innovating over a period of time to really drive that lower drug cost What do I think? There's a lot of discussion around a lot of different things relative to what's on the table today and what Washington is really looking at. I think that they're very concerned about transparency, so I think if anything does pass, it'll be relative around transparency. As a company, we are very transparent with our customers when we look at our value chain. We're supportive of transparency, we always have been, and we've been very focused on transparency as a company. The question is, does it make it to the floor? I don't know. But I do know that we're very much strongly advocating and making sure that people truly understand the value that we bring in the healthcare system and the focus of what we're trying to do as a company.

Okay, great. And then I appreciate that you did reiterate guidance, I think, in N8K yesterday. I guess, can you talk a little bit about some of those puts and takes that get us, that bridge us to 2024, but also outline some of those headwinds and tailwinds as we think about 2025? And maybe this goes back into the STARS discussion, too, to some extent, to the extent you can elaborate even more there. But also, you know, bigger picture Is double-digit EPS growth still the right long-term goal? And is it more about kind of your line, what's your line of sight to get to that goal and timing thereon, and especially given kind of the investments that you need to make in sort of the recent acquisitions as well?

Sorry, that's a big question. No, I'll have Karen fill in on the end on the goal, but I'd just reiterate on the, so you're not thinking about it throughout my answer. that absolutely our long-term goal is to reposition the company to generate the double-digit EPS growth right and the pathway there will be something that we talk a lot about I think at investor day but absolutely is that it's it's really one of the reasons we're embarking on this strategy right which is to fundamentally change the long-term growth rate of the company to get there For 2024, if you step back at least two cycles, really, we had laid out the $9 after we announced some of the deals for next year. We had some pressure against that from COVID and 340B, which we talked about. And we talked about our ability to offset that pressure through G&A savings. And literally, in the span of three or four months, you know, we executed a program to create that $700 million of GNA savings that we announced on the second quarter and we've taken the charge. In the second quarter, we saw some other moving pieces as well. On the pressure side of the equation, Medicare was the biggest one that is in that particular equation. And as I mentioned, what we had assumed was that the pressure we were already experiencing in 23 would carry through to 24 and that we'd even see some incremental pressure. So that was the singular biggest item that I would say to the negative. We also took down expectations for our PCW slash retail business as well. We did begin to see a little bit of consumer softening of demand in the second quarter. We expect the COVID contribution from that business to continue to decline as it has the last few years. So we took those down. One mechanical thing to remember that I should have started with is Our guidance never assumes prior year reserve development. That was worth about $0.05 through the last quarter. So you should take that out as well. On the positive side, our pharmacy services PVM business continues to do very, very well. We've raised our guidance probably at the last call about $500 million to that business this year. Not all of that will run right through. Some of that will get reset in the natural pricing of the business. We sort of had the annualization of the 340B effects, but that should be a positive driver for us as well. That picture is sort of what leads us more or less to like a big picture where adjusted operating income will be roughly flat from year over year in those businesses. So if you think about my explanation, you have HCB coming down a little bit. Obviously, that's where we're seeing stars. You'd have our retail business coming down a little bit. You'd have pharmacy going up a little bit. And because of the expense actions, we'd get a little pickup probably in corporate as well. But that's overall, it's flat. Share count and interest expense will roughly offset each other. And that's sort of how we get to the flat EPS. I think the big decision that for 2025, if we're fortunate enough to find ourselves in the position of having stars and a big pickup in stars revenue, we'll be thinking about the investments that we want to make in the business long term to get to that double-digit directory, or even in the near term in terms of Medicare growth. And some of this is always an iterative process to see how well you do in this growth year and do I want to generate more growth. So there will be a decision to make about sort of the full reclamation of all of the margin impact of STARS and at what pace should we do that? Are there things that make sense to invest some of that in as part of this long-term equation, especially in light of the assets we own now, I think are relevant to think that through as well. So you may end up deciding to spend that in more focused places, as an example, than just sort of broadly. But that will obviously, fortunately, If we're fortunate enough to find ourselves in that position, that'll be a big decision for 2025. And then we'd have a lot of the other natural growth drivers.

I just add to that on his point. I'm optimistic about our ability on stars. I just want to reiterate that.

Yeah.

Even on one of your largest plans as well. Yes. Okay.

Aaron, the only other thing on 2024 that sometimes gets missed a little bit as people think about their models and are looking at it is our, what we call our IFP business, which is our ACA exchange business, which we have a million lives in. They're $5 billion of revenue thereabouts. That is not a business that in 2023 is making a contribution to earnings. And I think at that scale, the benefit of getting to that membership that quickly is we are scaled. I think it's our intention to try to reposition that business, maybe not for full target profitability, but for some profitability. So you're taking something that's not contributing, making it a positive contributor. So when you think about how does our HCB business perform year over year, that's one dynamic that you need to think a little bit about inside there.

And presumably we'll hear better visibility on 2025 or next earnings or investor day? Investor day. Okay. And then I did want to touch on just, you mentioned investments, and I did want to touch on just capital deployment in general. And obviously the focus right now is executing on those core anchor assets that you've acquired. But, you know, what are the next steps in terms of finding other new sources of growth, but also, you know, building upon some of those more recent M&As at smaller companies? smaller deals that you're looking at from here on out, what are you looking at from an M&A?

Yeah, and I think, again, I would reiterate for everybody, the capital power, the capital generation of this business is incredibly strong, especially when you start thinking about this on a multi-year basis sort of strategically. And our construct that we've shared with you, I would say, is still intact, where 50% of the capital that we generate roughly would be available for M&A, delevering, buying shares back I'm putting the dividend in a separate bucket here I think in the near term right we have two large kind of premier assets so more M&A in the near term is certainly not the priority and so I'd say inside that bucket there might be more of a shift to the other uses certainly over time there are other capabilities that would make sense to bring into that vision I described at the beginning But we'd have a bias towards those being accretive. And we'd also, you know, it's never say never, but it's unlikely, right, that those would be of the size and scale potentially of what we've just did where we really needed kind of that anchor asset, that anchor capability to really power this value-based engine. So near-term, not nearly as much focus on M&A as the last two years have been. M&A plays a longer-term role, but not in the same way it has in the last two years.

If I could sneak one last one in here, just GLP-1s, if I could get just a quick comment, if net positive, negative across your enterprise entirely.

Yeah, you know, I would say it's probably a modest positive right now because in HCB, It's not covered on most of our fully insured for weight loss on most of our fully insured contracts unless the customer has bought a rider and only the minority of our Customers have done that and generally our pricing has been okay On that rider when in the concert of all the other things so it hasn't had a big impact on the fully insured business Most of the uptake that we've seen there is on self-insured where employers are electing to cover it for weight loss so we've seen tremendous volume of right, go through retail, but brand drugs don't proportionately kind of contribute to retail like they do, like generic drugs do. Not as big an issue in HCB, but we've seen some positive in our PBM business. Going back to Karen's point, this is like case exhibit A1 in the ability of a PBM to drive down costs for high-cost drugs, and you can really see it already on this class of drugs.

Great. Excellent. Thanks so much for the time. I appreciate it. Thank you. Thank you.