Despite CVS Health Corp.'s (CVS, Financial) acquisition of Aetna, creating a company that is twice as valuable, that value has yet to be fully realized in the company’s market capitalization. In fact, after a brief pop to $80 per share in November, the stock is off north of 20% in just two months, for what looks like macroeconomic fears rather than real danger.
Here are the facts. CVS is integrated throughout almost every aspect of the pharmaceutical supply chain. Now with Aetna, CVS is one of the premier health care providers in the world, processing over 1.4 billion prescriptions per year with over 20 million health insurance members and a network of more than 9,500 retail pharmacies and clinics.
More importantly, CVS has just signed a new multiyear deal with Walmart (WMT, Financial) to act as the company’s pharmacy benefit manager and Managed Medicaid retail pharmacy network. It’s an important agreement that will keep CVS in the leadership position going forward, especially as costs continue to rise.
While many believe CVS overpaid for Aetna, the deal could add almost $4 billion in net income in the first year alone and $60 billion in revenue. Once these line items become fully attributable to its financials, the stock will follow the numbers higher. Pharmaceutical spending is set to grow for years to come thanks to demographic shifts and the expansion of medical insurance coverage to the currently uninsured. CVS is expected to earn well over $7 a share in 2019 and, despite the debt load of $60 billion, the price multiple is off considerably.
The new business model does present a level of uncertainty in how the combined company will carry out its strategy. No risk, no reward in an industry that is ripe for change. Even at 15 times earnings, CVS shares would price in the $105 range, but considering the longevity potential and current 3% dividend, a multiple of 20 should be closer to fair value. At that level, the stock could hit $150 by the end of 2020. In either scenario, it is trading at a steep discount right now.
Disclosure: I am not long or short CVS or WMT.
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