Bulls See CVS Smoking Competition as Earnings Approach: Options

Even with a ban on tobacco sales forecast to slow earnings, CVS Caremark Corp. (CVS) shareholders still can’t seem to kick the habit of owning the stock.

Calls on CVS’s shares are near the most expensive level relative to puts in more than six years, according to data compiled by Bloomberg. The price relationship known as skew, which decreases as options traders become more bullish, is currently about 35 percent less than the three-year average.

With 48 million uninsured Americans that may turn to government exchanges for health coverage, growth in CVS’s pharmacy business will offset money lost from cigarette sales, according to Scott Eun of Standard Life Investments Inc. The company, due to announce first-quarter results tomorrow, has said the move to drop tobacco sales will cut earnings per share by 2 percent this year.

“CVS is becoming more and more of a health-care company, as opposed to pure retail,” Eun, a Boston-based senior vice president and portfolio manager at Standard Life, which oversees $305 billion, said in an April 28 phone interview. “It’s positioning itself to be one of the first points of entry for people accessing the health-care system. It’s not an investment that anyone will stress about.”

7,600 Pharmacies

The operator of 7,600 pharmacies has been increasing its footprint in health care, opening 800 in-store clinics nationwide with nurses and physician assistants who can diagnose and write prescriptions for minor illnesses.

CVS, the largest U.S. seller of prescription drugs, is forecast to report first-quarter earnings per share of $1.04, an increase of 28 percent from the previous period, according to analysts’ estimates compiled by Bloomberg.

The options market is implying a one-day move of 2.7 percent following the report, more than the 1.8 percent gain or drop after the last eight announcements. The stock gained after seven of the last 10 releases.

Puts protecting against a 10 percent drop in CVS shares cost 3.91 points more than calls betting on a 10 percent rally yesterday, according to three-month data compiled by Bloomberg. Skew fell to 2.93 April 4, the lowest level since December 2007. The measure has three-year average of 5.98 points.

Carolyn Castel, a spokeswoman for Woonsocket, Rhode Island-based company, declined to comment on the options.

Win-Win

CVS reported earnings that topped analysts’ estimates for the fourth quarter, citing an expanded roster of clients for specialty pharmaceuticals. The company is likely to keep adding customers, according to an April 13 client note from Leerink Partners.

“You get a below-market multiple for above-market growth,” Ross Muken, a New York-based analyst at International Strategy & Investment Group LLC, said in an April 28 phone interview. “By gaining share, they’re also able to grow their profits. It’s a win-win for the company and its shareholders.”

Profit at CVS has increased every year since 2005 and is poised to jump 12 percent this year, analyst estimates compiled by Bloomberg show. By comparison, Standard & Poor’s 500 Index companies are projected to earn 7.2 percent more in 2014. CVS has a price-earnings ratio of 19, cheaper than the average multiple of 25 for drug retailers in the U.S. equity benchmark.

Stocks Rotation

While most analysts covering the company have buy recommendations, the shares have been caught up in the market’s recent selloff. The stock, which gained 48 percent in 2013, slid 2.9 percent last month as investors dumped the biggest winners of the bull market.

CVS is included in the Russell 1000 Growth Index, which is made up of companies that have the highest price-book ratios and predicted earnings growth. The gauge is down 1.2 percent since the beginning of March compared with a 3.1 percent gain in the Russell 1000 Value Index.

“Rotations like this don’t tend to end quickly,” Tim Ghriskey, chief investment officer at New York-based Solaris Asset Management LLC, which helps manage about $1.5 billion, said in an April 29 phone interview. “It’s likely to persist for a while longer. These cycles tend to last longer than two months.”

About 7.5 million Americans have enrolled in insurance plans under the 2010 Patient Protection and Affordable Care Act. The insurance expansion may produce a surge for CVS of prescription orders as well as patients with sniffles and other minor maladies seeking to avoid high emergency room costs and long waits for doctor appointments.

Tobacco Sales

The company, which is ending tobacco sales by Oct. 1, called the move a public health initiative designed to reduce the almost half a million deaths attributed to smoking. The announcement quickly garnered support from public health advocates such as the American Medical Association and politicians including President Barack Obama and U.S. Senate Majority Leader Harry Reid, a Nevada Democrat.

Daily call trading has exceeded puts by an average of 1,227 contracts in the past 20 days, according to data compiled by Bloomberg. Options volume on CVS shares totaled 3,342 yesterday, about 12 percent less than average.

“CVS has put itself out there, differentiated itself versus Walgreens and said it’s really a health-care company,” Dane Leone, a New York-based analyst at Macquarie Group Ltd., said in an April 28 phone interview. “This is a savvy move, and positions the company very effectively versus their biggest rivals.”

To contact the reporter on this story: Joseph Ciolli in New York at jciolli@bloomberg.net

To contact the editors responsible for this story: Lynn Thomasson at lthomasson@bloomberg.net Michael P. Regan, Emma O’Brien

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