Steven Romick addressed the Value Investing Congress on May 3, 2011. He spoke about the state of the U.S. economy and gave analyses of several stocks from his current portfolio and advice to value investors. Below is an excerpt regarding his CVS (CVS, Financial) holding. The whole speech is available here.
When we first purchased CVS in 2010, it was trading at about 11.5x 2011‘s earnings. We felt the valuation adequately compensated for our concerns regarding their PBM business – as well as for our admittedly less robust understanding of its prospects. As CVS‘ stock price began to tick up, the PBM comps, Medco and Express Scripts, moved up even more, reducing the price of the CVS retail stub.
Using the PBM competition as a comp, we felt, at that time, that the Caremark value attributable to the total enterprise was about 46%. On that basis, the CVS stub traded to just 9.4x free cash earnings. We therefore ended up hedging a portion of the PBM exposure – to capture the lower valuation as well as to eliminate some of the risk and accompanying discomfort of what we don‘t know regarding the PBM business. At this point, we still have some PBM exposure, albeit reduced. We believe that Caremark can outperform its peer group as it is now being better managed by Per Lofberg, the former Medco head as its President, and is poised to benefit vis-à -vis its competition. Contributing to this will be better customer service, the aforementioned systems improvements, as well as the competitive advantage of their Maintenance Choice integrated model.
There has been some recent chatter about CVS potentially selling or spinning off Caremark to increase shareholder value. We believe there is a lot of opportunity to improve their PBM business and would prefer giving the new management team a couple years to execute on their plans. However, if Caremark ultimately fails to perform to its potential, its sale to a strategic buyer such as Medco or Express Scripts could be in the best interest of shareholders. One would then have to analyze how the benefits that currently accrue to each can be maintained. I have not yet seen evidence to support the argument that a spin-off would add much value, particularly since the combination of Caremark and CVS‘ businesses created the differentiated Maintenance Choice program and preserving that program after the spinoff or sale might prove problematic.
Since we decided to talk about CVS a month ago, its stock price has moved up, so I thought it important to reflect a more current valuation. Unhedged, the stock still seems reasonably priced at 13.0x 2011 earnings and 11.4x 2012‘s — hedging the PBM exposure creates the stub retail business at about 12x 2011 and 11x 2012 earnings. I wouldn‘t characterize CVS as any kind of homerun stock but it should nevertheless prove to be a solid compounder over the next few years as the aforementioned macro tailwinds begin to blow and are recognized by other investors.Also check out:
When we first purchased CVS in 2010, it was trading at about 11.5x 2011‘s earnings. We felt the valuation adequately compensated for our concerns regarding their PBM business – as well as for our admittedly less robust understanding of its prospects. As CVS‘ stock price began to tick up, the PBM comps, Medco and Express Scripts, moved up even more, reducing the price of the CVS retail stub.
Using the PBM competition as a comp, we felt, at that time, that the Caremark value attributable to the total enterprise was about 46%. On that basis, the CVS stub traded to just 9.4x free cash earnings. We therefore ended up hedging a portion of the PBM exposure – to capture the lower valuation as well as to eliminate some of the risk and accompanying discomfort of what we don‘t know regarding the PBM business. At this point, we still have some PBM exposure, albeit reduced. We believe that Caremark can outperform its peer group as it is now being better managed by Per Lofberg, the former Medco head as its President, and is poised to benefit vis-à -vis its competition. Contributing to this will be better customer service, the aforementioned systems improvements, as well as the competitive advantage of their Maintenance Choice integrated model.
There has been some recent chatter about CVS potentially selling or spinning off Caremark to increase shareholder value. We believe there is a lot of opportunity to improve their PBM business and would prefer giving the new management team a couple years to execute on their plans. However, if Caremark ultimately fails to perform to its potential, its sale to a strategic buyer such as Medco or Express Scripts could be in the best interest of shareholders. One would then have to analyze how the benefits that currently accrue to each can be maintained. I have not yet seen evidence to support the argument that a spin-off would add much value, particularly since the combination of Caremark and CVS‘ businesses created the differentiated Maintenance Choice program and preserving that program after the spinoff or sale might prove problematic.
Since we decided to talk about CVS a month ago, its stock price has moved up, so I thought it important to reflect a more current valuation. Unhedged, the stock still seems reasonably priced at 13.0x 2011 earnings and 11.4x 2012‘s — hedging the PBM exposure creates the stub retail business at about 12x 2011 and 11x 2012 earnings. I wouldn‘t characterize CVS as any kind of homerun stock but it should nevertheless prove to be a solid compounder over the next few years as the aforementioned macro tailwinds begin to blow and are recognized by other investors.Also check out:
