CVS Health Corp. (CVS, Financial) is a potential value opportunity at current levels, from my perspective. Wall Street analysts are leaning to the bullish side as well. At last count, CVS operates nearly 10,000 stores. It operates about 10% more locations than the second-largest drugstore chain and four times more stores than the third-largest. CVS filled 38.55% of retail drug prescriptions in the U.S. last year. The percentage is expected to grow to 40.55% in 2022 and 42.55% in 2023.
Morover, in this high-inflation environment that shows the potential to enter a recession, CVS' competive advantages and the stable nature of its business could provide safe harbor in a turbulent market. Overall, there is scant sentiment for shareholders to cash out.
Sum of its parts
Some may think of CVS just as a drugstore chain, but the company is more than that. CVS was fourth on the Fortune 500 list and seventh on Fortune’s Global List in 2021. The market cap is $140.74 billion. CVS expects to generate $304 billion or more in 2022 annual sales from a plethora of profit centers.
Front-store items are their own profit center, with CVS being the fist choice for many consumers in terms of things like joint braces, cosmetics, personal care items, detergent and wound plasters. They are also a popular stop for things like candy without the hassle of going to a supermarket, and they sell weird items like bacon bandages, tool belts and emergency underpants that are rare to find elsewhere. Front store sales rose 8.4% year-over-year in 2021.
Other profit sources are:
- Caremark pharmacy benefits manager - revenue in the health care benefits sector grew 9.4% in 2021.
- Pharmacy services - revenue was up 8% and adjusted operating income up 20.6% in 2021. In 2022, management expects revenue to grow 6% to 8% for this segment.
- Medicare membership - this business grew 11.6% year-over-year, with a 96% retention rate.
- In-store Minute Clinics - these have brought in 50+ million patients since their inception. They administered over 32 million Covid-19 tests and 60 million vaccines in 2021.
- The website - CVS' website gets over 2 billion hits a year. Revenue for online sales was up 55% in 2021. Customer traffic jumped 10%. Home prescription delivery is a valued feature.
- Aetna - CVS is still digesting the acquisition of Aetna insurance and its 39 million enrollees. Aetna reported a 9.5% increase in revenue year-over-year, much from increases in government business.
CVS demonstrates a strong commitment to sustainability and women’s health care services. The company sells 100 brands from diverse communities. More than 200 beauty, grocery, personal care, health, wellness and general merchandise products are sourced from Black-owned companies by the Supplier Diversity team.
Valuation
The share price of CVS gained ~50% in 2021. The revenue trend line is positive at 12.97%. However, shares pulled back between March of 2021 and March of 2022, declining 45%. Analysts have an average target price of $118 for the stock, though I estimate the shares can pop to $125 if inflation and the much talked-about recession turn out to be less severe than expected.
CVS is profitable, has momentum and the stock has a high but still fair valuation in my view. The GF Value chart seems to disagree, though, rating the stock as signficantly overvalued:
The 0.63 levered Beta is an important positive indicator. That is always good for the less risk-tolerant investors. Short interest is less than 1%. The return on equity is a positive 10.95%.
The dividend yield is 2.05%, and the company has 13 years of dividend growth under its belt. The yield is higher than the health care sector average of 1.5%.
CVS' next reporting date for earnings is May 4. The consensus estimates call for earnings per share of $2.16 for the quarter, 5% to 7% higher than last year’s $2.04, and for earnings per share of $8.10 to $8.30 for full fiscal 2022.
One last positive worth noting: Analytics firm Numerator reports that the average customer of CVS is an urban college graduate GenXer earning a high annual income of over $80,000. They visit stores about 22 times a year and spend over $20 each trip. CVS added more new shoppers than it lost last year.
Headwinds
A few headwinds could affect CVS. The company faces the same drags on the economy from inflation, labor and supply issues. Then there is the larger issue of governments and insurers looking for ways to make pharmaceuticals more affordable. The move to replace some essential life-saving drugs that have been marked up by over 1,000% in some cases with generics is gaining traction. There have even been some efforts to bypass more of the middle-men in the drug sales process, which could reduce the high markups. This can mean lower costs for the consumer but less profit for retailers.
Another point to consider is CVS' debt-to-equity ratio, which is 1.01. It is the highest ratio of companies in the health care sector, but down from its previous 1.39. CVS' debt was ~$60 billion in December 2021. That is about $9 billion less year over year. Its $12.5 billion in cash and equivalents leaves the net debt at $42.4 billion. It is a lot of debt relative to the market cap and earnings. Analysts suggest investors keep a watchful eye on this factor. On balance, the debt is less worrisome because free cash flow is greater than Ebit. I belive the company is managing debt well.
A healthy future
Overall, I think CVS has a healthy future. Expect to see more automation in their operations. The move will forefend labor cost increases. The company is investing $3 billion in “technology and digital enhancements” to counter plunging income from fewer Covid-19 vaccinations and testing. The e-pharmacy market topped $60 million in 2020. Revenue is expected to hit $136 million in 2026 with a CAGR of 13.84%.
The broad shoulders of CVS give it market power. Management is innovative while being aware of the need to control expenses. They have proven gutsy when it comes to using debt wisely for things like online marketing and the acquisition of Aetna. Dips in the share price could present an excellent opportunity for investors interested in this stock.
