CVS Pharmacy Segment Stabilizes; Institution Maintains Overweight Rating

Overview

This is the final installment of J.P. Morgan's 'CVS Health Week' series, specifically analyzing CVS's Pharmacy & Consumer Wellness (PCW) segment—the familiar CVS retail pharmacy and related pharmaceutical services assets. The report's central view is that although retail pharmacies have faced heavy reimbursement pressure in recent years, CVS, with its leading store scale, integrated asset portfolio, and the newly implemented CostVantage reimbursement model, has brought market expectations for this segment back to a reasonable level, showing signs of stabilization and even improvement. Based on this, J.P. Morgan maintains an Overweight rating on CVS.

Core views

Overall Positioning: The report sees CVS as possessing a 'unique' integrated asset set, where the retail pharmacy is the most frequent consumer touchpoint. It generates revenue for itself and also drives traffic and value to the Health Benefits (HCB) and Health Services (HSS) segments, serving as an important gateway to connect consumers, drive behavioral change, and steer healthcare toward lower-cost scenarios. Scale and Prescription Growth: According to institutional estimates, CVS retail pharmacy holds about 28%-29% of the prescription market share, with slightly under 9,000 stores in 2025 and adjusted prescription volume around 1.8 billion, making it the industry leader in terms of both store count and prescription share. Over the past four years, the company closed over 1,100 stores (about 1,168 from 2022 to 2025), yet adjusted prescription volume continued to grow, with a five-year compound growth rate of about +4%, and same-store prescription growth recently reaching around +8%. The report interprets 'closing stores while growing' as a signal of improved single-store economic efficiency—average adjusted prescriptions per store rose from about 126,000 in 2016 to about 199,000 in 2025, and the company says about 70% of prescriptions from closed stores were retained by nearby stores. Additionally, CVS acquired through bidding Rite Aid’s prescription files from 625 stores and 64 stores (covering 15 states), adding about 49 million additional prescriptions, providing tailwinds for the second half of 2025 and the first half of 2026. CostVantage New Reimbursement Model: This is a key source of optimism in the report. CVS launched CostVantage at its 2023 Investor Day—a more transparent reimbursement model directly linked to drug procurement costs (structured as 'drug cost × markup percentage + patient management fee'). It targets two longstanding industry pain points—cross-subsidies and continuously declining reimbursements, especially aiming to improve the economics of lower-margin brand drugs. The company converted all commercial contracts to this model in January 2025 and completed the transition for commercial third-party discounts, Medicare, and Medicaid lines in 2026. The report emphasizes that the new model may not directly boost profitability, but it can reduce cross-subsidies, bring greater stability and transparency, allowing the company to leverage prescription growth for operational leverage. Financial Performance and Guidance: Reimbursement pressure mainly shows up in gross margins, with PCW gross margins dropping from 26%-27% in 2019-2021 to about 18.5% in 2025, meaning CVS faces annual gross margin headwinds of about $1 billion. On the other hand, store closures have boosted efficiency, reducing operating expenses as a percentage of sales by about 445 basis points over three years—but the weak gross margin largely offsets these cost savings. For 2026 guidance, the segment revenue forecast is at least $136.5 billion (down about 2% year-on-year, partly due to weaker consumption), and adjusted operating profit guidance is at least $6.18 billion (up about 2% year-on-year). Notably, at its 2025 Investor Day, the company revised its long-term operating profit outlook for PCW from the original 'at least -5% lower limit' to 'at least flat,' and Q1 performance exceeded management expectations, enabling it to raise segment guidance and increase investment simultaneously. Integrated Services: The report also details several cross-segment integration initiatives, viewing them as CVS’s competitive moat distinguishing it from peers. For example, Maintenance Choice allows mail-order-oriented plans to pick up medications at CVS retail stores at mail-order prices. The report notes that the marginal cost of dispensing one extra prescription at retail stores is lower than mail order (which requires additional packaging and shipping costs), making it more beneficial for the whole enterprise and potentially driving acute prescriptions and in-store sales. While similar programs like 'Retail 90' exist at Evernorth and OptumRx, they don’t simultaneously offer both mail-order and retail channels, lacking CVS’s integration depth. Pharmacy Advisor provides one-on-one pharmacist consultations to improve medication adherence, having delivered over 54 million adherence interventions since launch.

Analysis framework

The report follows a logical progression—from business breakdown to scale and efficiency, reimbursement mechanisms, and financial validation. First, it breaks down the business: separating PCW into core retail pharmacy (prescription dispensing, vaccines, diagnostics, and other pharmaceutical services, accounting for over 75% of segment revenue, reaching 83% in 2025) and front-store merchandise (OTC drugs, consumer health, beauty and personal care, etc.). Using a cash flow/product flow diagram, it uses a commercial health plan example to clearly illustrate who pays whom and who delivers goods to whom among members, plan sponsors, PBMs, pharmacies, distributors, and manufacturers, helping readers understand exactly where pharmacy revenue comes from. Next, it looks at scale and efficiency: institutions use metrics such as 'prescriptions per store' and 'same-store prescription growth exceeding overall growth' to show that store closures haven't crushed sales but instead boosted single-store output and operational leverage. Then, it examines the reimbursement mechanism: the report explains the root cause of pharmacy gross margin pressure—the PBM’s pricing power during contract renegotiations (occurring roughly every three years), and how, as generic drug penetration peaks and the 'cross-subsidy' benefits from generics subsidizing brand drugs gradually fade, CostVantage offers a targeted solution. Finally, it cross-validates with financial data: presenting figures like declining gross margins, improving expense ratios, and upgraded guidance to confirm the view that 'cost side is improving, gross margin remains under pressure, but the overall situation is stabilizing,' ultimately supporting the maintenance of an Overweight rating.

Methodology notes

• Industry/Industrial Analysis FrameworkUpstream-Midstream-Downstream Industry Chain Transmission

  Decomposing the Pharmaceutical Payment and Distribution Chain (from manufacturer—distributor—PBM—pharmacy—plan sponsor—member cash flow and product flow)

  The report uses a 'cash flow/product flow' diagram to clearly explain how money and goods move through each link in the pharmaceutical industry. Understanding this chain helps clarify why pharmacy revenue primarily comes from PBMs and payers rather than consumers, and also explains why PBMs hold the upper hand in reimbursement negotiations—this is fundamental to understanding pharmacy profitability logic.

• Competition and Strategy FrameworkMoat / competitive advantage

  The 'channel neutrality' integration advantage from simultaneously owning both mail-order and retail channels

  The report points out that CVS owns both mail-order pharmacies and retail pharmacies, achieving 'channel neutrality' and thus reducing conflicts of interest, whereas competitors only own one channel and lack integration depth. This is a 'moat' analysis—assessing whether a company has structural advantages others can't easily replicate, enabling it to retain customers and win new business.

• Company Fundamentals and Financial FrameworkOperating/Financial Leverage Analysis

  Operational leverage from increased prescriptions per store, and reduced expense ratio following store closures

  The report uses 'average prescriptions per store rising from about 126,000 to about 199,000' and 'expense ratio falling by about 445 basis points over three years' to illustrate: when fixed costs are spread across more prescriptions and inefficient stores are closed, unit efficiency improves—this is operational leverage. It explains why store closures can actually improve segment profitability.

• Industry/Industrial Analysis FrameworkVolume vs. Price Decomposition

  The offsetting forces of prescription 'volume growth' and 'declining reimbursement price per prescription'

  The report breaks down pharmacy profitability into 'volume' and 'price' components: prescription volume continues to grow ('volume growth'), but the reimbursement price per prescription declines due to PBM price cuts and fading cross-subsidies ('price decline'), offsetting each other and still dragging down gross margins. This volume-price decomposition helps readers assess the 'gold content' of revenue growth.

• Competition and Strategy FrameworkEconomies of scale / learning curve

  The marginal cost of dispensing one extra prescription at retail stores is lower than mail order

  The report points out that a pharmacy already dispensing 250 prescriptions daily has extremely low additional costs for dispensing one more, while mail order would incur extra packaging and shipping costs. This is a typical marginal cost/economies of scale approach—existing scale spreads the costs of new business, so keeping prescriptions at retail stores is actually more cost-effective for the whole enterprise.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• CVS Health Corp (CVS.US)

  The primary focus of this report, benefiting from PCW segment stabilization, CostVantage implementation, store efficiency improvements, and Rite Aid prescription integration

  Strengths

  First in retail pharmacy market share (about 28%-29%), leading store and prescription scale; integrated assets with both mail-order and retail channels, offering 'channel neutrality' advantage; improved single-store efficiency and reduced expense ratio, enhancing operational leverage.

  Weaknesses

  PCW gross margin fell from 26%-27% to about 18.5%, facing annual gross margin headwinds of about $1 billion; front-store sales dragged down by weaker consumption; 2026 revenue guidance down about 2% year-on-year.

  Comparison

  The report points out that Evernorth and OptumRx have similar 'Retail 90' programs, but neither simultaneously owns both mail-order and retail channels, lacking CVS’s integration depth.

  Risks

  Continued pressure on pharmacy reimbursements: PBMs have pricing power during contract renegotiations roughly every three years, leaving gross margins vulnerable to further pressure; fading cross-subsidy benefits: generic drug penetration peaked (over 90% of prescriptions), and the profit structure previously supported by generics subsidizing brand drugs is weakening; the new model may not necessarily improve profitability: the report notes that CostVantage could bring stability but might not directly boost pharmacy profitability; weaker consumption: management attributes part of the 2026 revenue decline year-on-year to weaker consumer momentum, impacting front-store sales and overall revenue.

Key data

• Retail Pharmacy Prescription Market ShareAbout 28%-29%Increased from about 26% in recent years, benefiting from Rite Aid prescription acquisition and Walgreens store closures
• Number of Stores in 2025About 9,057 (slightly below 9,000 count)Down from a peak of about 9,982 in 2021
• Adjusted Prescription Volume in 2025About 1.8 billion (1802, based on 30-day equivalents)Five-year compound growth rate of about +4%, with same-store prescription growth recently around +8%
• Cumulative Store Closures Over Four YearsAbout 1,168 (2022-2025)About 70% of prescriptions from closed stores were retained, and future closure pace is expected to slow down
• Average Adjusted Prescriptions Per StoreFrom about 126,000 in 2016 to about 199,000 in 2025Single-store efficiency improvement, a positive sign of operational improvement
• PCW Gross MarginAbout 18.5% in 2025, compared to 26%-27% in 2019-2021Reimbursement decline is the main drag
• Annual Gross Margin Headwinds$1 billion/yearThe magnitude of annual gross margin headwinds highlighted by the company due to reimbursement pressure
• Expense Ratio (as % of Sales)Down about 445 basis points over three yearsCost savings from store closures
• 2026 Revenue GuidanceAt least $136.5 billion (down about 2% year-on-year)Partly due to weaker consumption, but still expecting prescription growth and full-year contribution from Rite Aid deal
• 2026 Adjusted Operating Profit GuidanceAt least $6.18 billion (up about 2% year-on-year)Long-term AOI outlook revised from 'at least -5% lower limit' to 'at least flat'
• Rite Aid Prescription AcquisitionPrescription files from 625 stores + 64 stores (covering 15 states)Adding about 49 million additional prescriptions

Impact & implications

The report believes that CVS retail pharmacy, as the most frequent consumer touchpoint in the healthcare system, has significant synergistic and traffic-driving value for its PBM (CVS Caremark) and health benefits businesses. With the implementation of CostVantage, ongoing store optimization, and the integration of Rite Aid prescriptions, the long-stressed PCW segment is stabilizing, and 2026 could see adjusted operating profit growth for the second consecutive year. Based on this, the institution views the strategic alignment and value of this segment as increasingly evident, maintaining an Overweight rating on CVS as a whole. It's important to emphasize that these are the report's own views, and whether gross margins can truly stabilize still depends on the evolution of the reimbursement environment.

Risks

• Continuous pressure on pharmacy reimbursements: PBMs have pricing power during contract renegotiations roughly every three years, leaving gross margins vulnerable to further pressure.
• Fading cross-subsidy benefits: Generic drug penetration peaked (over 90% of prescriptions), and the profit structure previously supported by generics subsidizing brand drugs is weakening.
• New model may not necessarily improve profitability: The report notes that CostVantage could bring stability but might not directly boost pharmacy profitability.
• Weaker consumption: Management attributes part of the 2026 revenue decline year-on-year to weaker consumer momentum, impacting front-store sales and overall revenue.

What to watch

• The actual impact of CostVantage implementation on gross margin stability (initial signs already seen in Q1).
• Whether PCW adjusted operating profit can meet 2026 guidance and achieve growth for the second consecutive year.
• The pace of store closures and subsequent trends in prescriptions per store and same-store prescription growth.
• The incremental contribution from Rite Aid prescriptions and store acquisitions from the second half of 2025 to the first half of 2026.