Two of our health care picks recently also reported earnings, however, their stocks displayed distinctly different trading after their releases. 

 

Teva Pharmaceutical Industries (TEVA), the Israel-based generic drug company, saw its profits rise 28 percent in the 3rd quarter versus the year-earlier period. Excluding one-time items, net income rose to $806 million, or 89 cents a share, from $630 million or 77 cents, in the year-earlier period. Revenue, which increased 25 percent to $3.55 billion, actually fell slightly short of analysts’ expectations, but the earnings per share did beat those expectations by a penny.

 

The company’s third quarter operations were helped by sales of the company’s most important name-brand drug, Copaxone, which is used to treat multiple sclerosis. In addition, savings relating to last year’s $7.4 billion acquisition of Barr Pharmaceuticals were also a factor. The company generated a record $1.03 billion in cash flow during the quarter, and noted in its conference call that it will be seeking more acquisitions in the coming quarters. 

 

Teva remains the worldwide leaders in generic drugs. Tailwinds to its business stem from an aging population lending to more prescription drug usage, as well as some major name brand drugs coming off patent in coming quarters. Strong growth appears as a relative certainty for Teva, and is still not priced into shares. We remain buyers.

 

Another healthcare play in our portfolio, CVS Caremark (CVS), also reported earnings recently that beat estimates. The company, which operates both a retail pharmacy and a mail-order pharmacy benefits (PBM) business reported revenues of $24.6 billion as same store sales rose by 5.7 percent compared to the year ago period. The company reported consensus-beating earnings per share of 65 cents, beating estimates by a penny. And while this is a great quarter at first glance, the stock sold of by 20 percent as the company noted on its conference call the loss of major contracts from its PBM business. 

 

The contracts, totaling about $3.7 billion, were only partially offset by new business, and justly is a major concern for shareholders. Since buying Caremark in 2007 for $22 billion, CVS has set itself up to reap major synergies from an internal partnership. As an example, the company launched a program called Maintenance Choice whereby mail-order clients can buy their prescriptions at lower prices if they pick them up from a CVS store. The thinking goes that what the company may lose on the drug sale, it will be more than made up for in profits from front-store sales (the toiletries, office supplies, food, and other merchandise sold at CVS stores) which hold greater profit margins for the company. The program has some traction, as the company noted 13 percent of PBM clients have signed up, and ample room to grow. 

 

The concern is now whether CVS Caremark can even hold onto their PBM clients. The contracts were lost to standalone PBM companies, and it remains to be seen whether this is the beginning of a trend. 

 

The loss of business has forced the company to temper its expectations of low-teens earnings growth for 2010, and we have reduced our expectations as well. We think the business model could certainly be beneficial if it is well-executed, but we’ll likely have to wait for the current quarter report to see if the contract losses were a one-time event. In the meantime, we will continue to try to glean more information from the company’s filings and public statements. Our thinking remains that the domestic pharma business has the tailwinds mentioned above, and CVS (and other drug providers) would also likely benefit from more insurance coverage for American should healthcare reform pass through Congress. Shares are cheap, even if you don’t include the company’s PBM business, but we remain cautious and rate them a hold.