CVS Health Corp. (CVS, Financial) is a health products retailer and integrated health care services provider. It is also a classic example of a financially robust giant trading at low valuations, in my opinion.
The company has played a key role in Operation Warp Speed with respect to the delivery of Covid-19 vaccines to U.S. citizens. Amazon's (AMZN, Financial) entry into the pharmacy space had been a major cause of concern for CVS shareholders, but the company has managed to hold its ground in 2020.
The new CEO, Karen Lynch, who took over from Larry Merlo from February, is expected to continue the company's growth story. Retail and long-term care are strong drivers for growth, but the stock also trades at a discount to my intrinsic value calculation, so I maintain my "Outperform" rating.
Financial performance
CVS Health had a particularly strong 2020, which was demonstrated through a string of good results. For the most Q4 result, the company reported revenue of $69.31 billion, which was a 3.93% growth as compared to the $66.68 billion reported in Q4 2019. Strong growth in retail and pharmacy services helped offset the slow performance in the healthcare benefits business, and CVS Health was able to surpass the analyst consensus revenue estimate of $68.73 billion.
The company reported a gross margin of 16.89% and an operating margin of 3.48%, which was lower than that in the same quarter of last year but it still managed to deliver an earnings beat. CVS Health reported net income of $973 million and adjusted earnings per share (EPS) of $1.30, which was above the average Wall Street expectation of $1.24.
The highlight of the result was the fact that the company generated a staggering $3.57 billion in the form of operating cash flows but spent only $1.23 billion in investing activities during the quarter, leaving it with strong free cash flows.
Heavy 'conglomerate discount'
CVS Health's business goes far beyond the average neighborhood pharmacy. The company is also a pharmacy benefits manager, an insurance company and a government contractor. Its $69 billion acquisition of Aetna, one of the U.S.'s largest health insurance players, has made it a true healthcare conglomerate.
While the company continues to derive strong cost synergies from Aetna and its other parallel businesses, its overall valuation in the market remains below par with what I like to call a "conglomerate discount," even after the recent stock surge. The conglomerate discount refers to how investors often assign lower valuations to conglomerates than they would the individual businesses that make up the conglomerates.
A good example of this low valuation is CVS Health's price-sales ratio, which is 0.37 whereas the median ratio for the Healthcare Plans industry is 1.4. It is worth highlighting that the company provides a far more personal touch to consumers within its ecosystem with the presence of its HealthHUB health clinics, which also gives it an edge over new entrants like Amazon. The company is planning to expand the number of HealthHUBs by another 1,500, which is indicative of the aggressive growth mindset. All these factors point towards a strong future growth trajectory.
Expected macro-economic tailwinds
CVS operates in a strong macro-economic environment. With the aged population of the U.S. rising rapidly, all its business ranging from pharmacies to health insurance to clinics should witness strong growth through the sheer expansion of the healthcare pie. For example, the CDC expects a 46% rise in adult flu vaccinations administered in pharmacies by November 2021, which could be a huge upside. In the short term, there is obviously expected to be a strong boost of revenues through the delivery of Covid-19 vaccines and Eli Lilly's (LLY, Financial) antibody therapeutic as a part of Operation Warp Speed. The sheer diversification of offerings that the company has gives it the power to keep customer retention rates high and keep them within the CVS ecosystem in order to counter the Amazon threat.
Final thoughts
CVS Health is one of the very few healthcare companies that appears fairly valued on the GuruFocus Value chart. However, most of its multiples are astoundingly low, in my opinion. The company trades at a price-earnings ratio of hardly 13.62 and a price-book ratio as low as 1.39.
Whether it is the heavy diversification of healthcare businesses or Amazon's entry into the pharmacy domain that is keeping the valuations low is unclear. However, I believe that if the company continues delivering good results, there should be significant value unlocked in the stock given the immense scope for multiples expansion. Overall, I believe that the stock is worth grabbing at current levels.
Disclosure: No positions.
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