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Nathan Parsh
Nathan Parsh
Articles (117) 

The Market Continues to Misprice CVS Health

CVS Health Corp.'s second-quarter results came in above expectations

August 06, 2020 | About:

CVS Health Corp. (NYSE:CVS) recently reported second-quarter earnings results that beat Wall Street’s estimates on both revenue and earnings front. The company’s quarterly report showed that the business performed well in an adverse environment. Results towards the end of the quarter and through July were especially strong.

The stock is higher by almost 6% since the last time I reviewed the company, but the stock still trades with a single-digit forward price-earnings ratio. Thus, I think we are still in the midst of a golden opportunity to acquire shares of CVS Health at a low valuation.

Quarterly highlights

CVS Health reported earnings results on Aug. 5 for the three months ending June 30. Revenue improved 3% year-over-year to $65.3 billion, coming in nearly $1.1 billion above what Wall Street analysts had expected. Adjusted EPS increased 75 cents, or 40%, to reach $2.64, which topped estimates by 72 cents. Net income was higher by 55% to just under $3 billion. The difference in EPS and net income growth was a higher share count in the most recent quarter.

The Pharmacy Services segment grew sales by just 0.1%, though adjusted operating income was up 2.4%. Total pharmacy claims increased 3.4% to 505.4 million. This segment benefited from the growth in specialty pharmacy as well as brand inflation. CVS Health saw an influx of 90-day prescriptions during the first quarter as consumers stocked up on medications. This impacted prescription volumes in the most recent quarter. New customers helped to make up for reduced new therapy prescriptions as fewer visits were made to providers. Fewer commercial memberships and pricing pressure were also a headwind during the quarter.

For the 2021 pharmacy benefit management selling season, CVS Health Corp. agreed to new deals worth a net total of $3.4 billion. The vast majority of deals have been agreed to and the company has a 98% retention rate.

Revenues for the Retail/Long-Term Care segment improved 1%, but operating income declined nearly 37%. Higher expenses to protect consumers and employees were responsible for this drop. Pharmacy drug mix and retail pharmacy prescription volumes were higher for the quarter. However, reimbursement pressure, recent generic introductions and a 1.1% decline in long-term care prescription volumes impacted results. Also effecting results was a 4.6% decline in front of store sales due to the Covid-19 pandemic. Front of store sales did benefit from higher average basket size as consumers stocked up on products.

Overall, retail pharmacy same-store sales were up 2.4% year-over-year. Pharmacy sales were higher by 4.6% and prescription volumes increased 0.6%. Front of store sales decreased 4.5%. The company’s market leading pharmacy script share increased 40 basis points to 26.9%.

Health Care Benefits was the main driver of growth during the quarter, as sales were higher by 6.1%. Adjusted operating income improved almost 141% due to lower benefit costs. The medical benefit ratio, which is the percentage of premium revenue spent on medical care and services, improved 1,370 basis points to 70.3% as customers were forced to put off elective surgery. This ratio will likely increase in future quarters as delayed surgeries are performed. This segment saw a 3.3% increase in total memberships during the quarter to 23.6 million. While commercial memberships declined 2.1%, government memberships were up 22.4%.

Growth during June and July shows that CVS Health’s products and services are in high demand.

Source: CVS Health Corporation’s Second-Quarter Earnings Presentation, slide 18

While CVS Health was down across the board in May, business accelerated in June and was solid in July as states began relaxing social distancing guidelines and consumers returned to more normalized purchasing habits.

Front of store sales were especially strong in July and returned to a more normal growth pattern for the company. Prescriptions sales and volumes were solid during the month as well.

CVS Health ended the second quarter with current assets of $62.5 billion, which includes $17.5 billion of cash, cash equivalents and investments. This compares to $63.7 billion of current liabilities, including $8.2 billion of debt due within one year. Given the company’s cash balance, debt payment likely won’t be an issue. CVS Health repaid $1 billion of debt during the quarter and $2.75 billion in July. Long-term debt was $63.7 billion at the end of the quarter.

The company also generated $7.1 billion of cash flow from operations during the quarter. CVS Health maintained a healthy liquidity position with $6 billion in borrowing capacity in addition to the cash on the balance sheet.

CVS Health offered revised guidance for the remainder of 2020. Adjusted EPS is now expected in a range of $7.14 to $7.27 for the year, up from $7.04 to $7.17 at the time of the last conference call. The midpoint of this guidance represents 1.8% growth from the previous year. Not terribly impressive growth, but still above consensus estimates of $7.14 for EPS. Wall Street analysts expect revenue of $267 billion for 2020, which would be a 4% improvement from last year.

Using the current price of $64.57 and the midpoint for EPS for 2020 of $7.21, shares of CVS Health have a forward price-earnings ratio of just 9. This is an increase in price since I last looked at the company, but still at a deep discount to the 10-year average price-earnings ratio of 14.1.

Due to the company’s market leadership in prescriptions, I continue to believe that shares of CVS Health are worth somewhere between 12 to 14 times earnings. Applying the midpoint for EPS estimates produces a target price range of $87 to $101. Therefore, I believe CVS Health to be 34% to 55% undervalued at the current price based off my valuation target range. The stock also provides a 3.1% dividend yield, which should appeal to income investors.

Final thoughts

CVS Health Corp. managed to top analyst estimates for the most recent quarter for both revenue and EPS. While certain segments had muted growth due to the Covid-19 pandemic, the company had much improved growth during the months of June and July.

CVS Health has been paying back debt used to finance the Aetna acquisition in late 2018. Cash flow generation has been very good, making it likely that the company will be able to continue to meet its obligations.

Shares of the company continue to trade with a single-digit multiple, so in my opinion, buying CVS Health today could allow investors to take advantage of a market mispricing. Investors could see excellent returns even if the stock trades with a slightly below average earnings multiple. For these reasons, I continue to rate CVS Heath Corp a buy.

Author disclosure: the author has a long position in CVS Health Corp.

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About the author:

Nathan Parsh
I am originally from Detroit, Michigan, before moving to Maryland to begin a career as an educator. This is my 14th year teaching. My wife and I have two young children who keep us on our toes.

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