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With medical costs continuing to bubble, eroding CVS Health's (CVS) previous FY24 EPS outlook, the retail pharmaceutical and health insurance giant is beginning to institute sweeping changes. CEO Karen Lynch is replacing the top executive at Aetna, CVS's insurance arm, after another disappointing quarter. Meanwhile, CVS announced a $2.0 bln cost-cutting plan, leaning on AI to streamline operations.

Like the rest of the retail pharmaceutical industry, CVS is struggling to escape sticky economic challenges. Walgreens Boots Alliance (WBA) announced in June it would shutter around 25% of its U.S. stores. The company is also reviewing its Boots U.K. business. Meanwhile, Rite Aid filed for Chapter 11 bankruptcy in October, closing hundreds of its locations nationwide.

With so many moving parts, investors' reactions are somewhat mixed today. On the one hand, CVS's overhaul could be what offsets stubborn medical cost pressures. However, it could take months before these actions produce any tangible benefits, especially given that the economic picture does not show signs of noticeable improvements.

• CVS's Q2 numbers reflected the sluggish economic landscape, delivering EPS of $1.83 and revs of $91.23 bln, a 17% decline and 2.6% jump yr/yr, respectively. In Health Care Benefits, which includes Aetna, the medical benefit ratio (MBR) -- the lower, the better -- edged 340 bps higher yr/yr to 89.6%, underpinning how quickly costs have jumped. As a result, adjusted operating income plummeted by 39.1% yr/yr. CVS attributed the weakness to the decline in its Medicare Advantage (MA) star ratings for 2024, which stoked concerns when first announced in October 2022.
• In Pharmacy & Consumer Wellness, which includes the retail side, revenue inched 3.7% higher yr/yr, supported by increased prescription volume and drug mix, which were partially offset by continued pharmacy reimbursement pressure, increased generic drugs, and sliding front store volume. CVS did grow its pharmacy market share, an encouraging development that could keep this segment trending higher over subsequent quarters.
• Health Services, CVS's largest segment by revenue as it houses its medical clinics and PBM offerings, contracted by 9% yr/yr. Notable highlights were Signify, which delivered another quarter of record volume, and Oak Street, which boasted a nearly 30% jump in at-risk patients yr/yr. However, these bright spots were overshadowed by the previously announced loss of a large client and ongoing pharmacy client price improvements.
• Looking ahead, with climbing costs eroding adjusted operating income, CVS lowered its FY24 EPS outlook again in Q2, projecting $6.40-6.65, down from at least $7.00 and below its initial outlook of at least $8.50. CVS also hiked its MBR forecast to 90.6-90.8% from 89.8%.

Rising costs will likely remain the main theme at CVS. The MBR tends to pick up during the back half of each year as the summer months unwind and patients begin scheduling more procedures. CVS warned that if MBR trends persist at elevated levels, it may be required to take an in-year 2024 premium deficiency reserve in its Medicare business, which could alter the cadence of EPS between Q3 and Q4. We commented last quarter that too much uncertainty surrounds CVS. We maintain this view and continue to urge caution in playing a rebound in CVS.