- Integrated Business
- Intelligent acquistions
- Shareholder Friendly
CVS Health Corporation (NYSE:CVS) is a health care company involved in the provision of integrated health care services in the U.S. Businesses of the company include retail pharmacy, caremark, a pharmacy benefit management and mail service, minute clinic, a network of retail medical clinics, and CVS specialty that includes pharmacy services for patients requiring treatment for rare and complex medical conditions. CVS is the largest integrated pharmacy health care provider in the U.S. with around 7,800 retail pharmacies, more than 1,000 walk-in medical clinics and 70 million members of its pharmacy benefit plan. The company also operates 24 retail specialty pharmacy stores and 11 specialty mail order pharmacies. Reportable segments of the company include pharmacy services, retail pharmacy and corporate.
Net sales totaled $139.37 billion during 2014, an increase of 9.9% on a year-over-year basis. The company generates most of its revenue from pharmacy services segment. The segment brought in $88 billion during 2014, which is 63% of the total revenue. Retail pharmacy revenue amounted to $67.80 billion during the same period. More than 70% of retail pharmacy revenue is associated with the sales of prescription drugs. CVS Health Corporation was founded in 1892 and is headquartered in Woonsocket, Rhode Island.
Thesis
CVS' scale makes it a cost leader in the industry. It is the largest retail clinic in the U.S. with 25 million patient visits to date.CVS' integrated business model is its distinct competitive advantage; CVS caremark claims are converting into more pharmacy sales, as claims routed to CVS pharmacy increased from 19% in 2008 to 31% in 2014. Enterprise channel sales are also increasing amid CVS Caremark; claims rose from 275 in 2008 to 430 in 2014. The point is that integrated health care services can provide a boost to individual business segments. Further, CVS is outperforming competitors in prescription sales. CVS' prescriptions grew 38% during 2009-2014 as compared to the 14% growth posted by other drug chains.
CVS is making some intelligent acquisitions, which is positive for the future outlook of the company. Acquisition of Target's pharmacy business increased CVS' footprint in the market, which will lead to market share gains going forward. The margin will also get a boost as pharmacy retail is a higher margin business as compared to pharmacy services. The other acquisition, Omnicare, complements CVS' specialty business segment. Industry trends are favorable for this niche. The senior population is expected to increase 50% by 2030, which will increase specialty care demand. The specialty health care market is expected to grow at CAGR of 16% during 2014-2018. With 35+ year specialty experience and recent acquisition of Omnicare, CVS is well positioned to capitalize on the growth prospects of specialty market. Note that Omnicare is expected to add 20 cents to the EPS of the company in 2016.
CVS is a shareholder friendly company, which is evident from its dividend and buyback track record. Dividends grew at CAGR of 27% while share repurchases grew at CARG of 25% during 2010-2015. The company is aiming to return $5 billion to investors during 2015. Dividend growth of 18% p.a. is CVS' target until 2018. Further, the company is planning to return $4 billion to $5 billion to its shareholders through repurchases each year.
Double-digit growth is expected in the coming years. CVS has guided for double-digit revenue and EPS growth until 2018, which indicates that the company might not be expensive on a forward PE of ~18. Another thing worth mentioning is that CVS teamed up with Cardinal Health to buy generics at a deep discount, which will provide a boost to the margin of the company.
To review, CVS is a leading health care services company that can compete on costs with its scale and unique integrated business model. Recent acquisitions are well aligned to provide a boost to the company's bottom line. The stock is attractive for investors given the double-digit growth expectations for CVS and a friendly capital return policy.
Thesis risks
The company's exit from tobacco will continue to put pressure on the earnings. $2 billion was lost in revenue during 2014, and the company expects to lose $1.5 billion during 2015 deteriorating EPS by 8 cents to 9 cents.
CVS' competitor Walgreens Boots Alliance (WBA, Financial) had an impressive quarter. Revenue grew by 48% during the most recent quarter. On the other hand, CVS' revenue increased by 11%. For 2015, analysts are expecting top line growth of 35% for Walgreens Boots Alliance while CVS' revenue is expected to grow 11%. This is indicative of CVS' market share loss to Walgreens. Despite a higher revenue growth of Walgreens, it's cheap on PE (TTM) as compared to CVS.
CVS' margin is also under check. The company is underperforming its peers including Walgreens and Rite Aid. CVS' pharmacy services are growing at a faster pace as compared to pharmacy retail resulting in an unfavorable mix.
Valuation metrics are not so compelling. Despite a relatively lower revenue growth for CVS, it's cheap on PE (TTM) as compared to CVS. A Monte Carlo simulation, which accounts for input uncertainty in the same residual earnings model, outputs a distribution of possible values ranging from $90.40 to $110.70. The most likely value predicted by Monte Carlo simulation is $99.09, translating into a 5% downside. See the chart below:
Source: Prudena
Bottom line
CVS is a bullish story amid dominating market position, integrated health services, specialty market growth and intelligent acquisitions like Target and Omnicare. It's also attractive due to its dividend yield growth and accelerated share repurchases. The exit from tobacco will improve the company's brand image over a longer run. Despite being expensive on PE (TTM), the stock is trading at a discount to Walgreens on forward PE. Gross margin is lower but the company is posting a higher net margin as compared to its peers due to cost savings from its scale of operation. Margin is also going to improve due to expanded footprint in retail through Target's acquisition. All in all, CVS remains a buy.
A different version of the article with valuation focus appeared on Prudena.
