Is CVS Due for a Bounce Back?
- By Stepan Lavrouk
While the health care sector as a whole has not done particularly well over the last year, CVS Health Corp. (CVS) has managed to underperform even that poor trend. Is this a company entering a debt spiral, or is there a method to what management is doing?
What is the strategy?
The key to evaluating CVS is to understand its long-term strategy. For the last decade or so, the company has been attempting to consolidate various parts of the health care vertical under one roof. In 2006, it acquired Caremark RX. Then, it acquired Omnicare in 2015. Both companies are prescription benefit managers - which negotiate with drugmakers on behalf of commercial health care insurers, plans of self-insured individuals and various government health care plans such as Medicare. These mergers have turned CVS into one of the most significant PBM players in the U.S. Today, PBM accounts for 48% of its revenue.
Then, in 2018, CVS acquired health insurer Aetna for a whopping $78 billion. This has left the company with an enormous debt load to pay off, which has made investors somewhat skittish, particularly after seeing General Electric (GE), another iconic American company, be undone by its excessive leverage.
To make matters worse, CVS was widely perceived to have overpaid for Aetna. As a result, the stock has lost almost 40% of its value since the deal closed. So the big question now is whether the company can integrate Aetna into its core business in a way that would be accretive to earnings and whether it can continue to pay down its debt load.
What are the risks?
A commonly cited legislative risk for shareholders of CVS is the idea of a Medicare for All. The worry is that such a proposal would virtually eliminate insurers and managed care providers, resulting in a hefty hit to CVS's earnings. Eliminating private insurers, however,would require some other actor to pick up the slack, and that institution does not currently exist. Therefore, it is unlikely legislators will choose to go for the nuclear option. It is more likely that Congress will look to expand existing health care coverage, which would be a boon to the company's managed care subsidiaries.
A more realistic risk would be if regulators came after the notoriously opaque practice of prescription benefit management. If legislators demanded that the industry simplify its procedures and bring costs down, margins would take a hit.
Finally, as with all brick-and-mortar retail these days, online competition remains an issue. While health care is relatively insulated from the pressure of companies like Amazon (AMZN). Yes, getting prescriptions filled online and having them delivered to your door is a great thing, but, at the end of the day, health care is an intensely consumer-facing industry. Patients are still going to need to speak to qualified pharmacists and nurse practitioners about the medications they take. CVS has also invested heavily in digitizing the customer experience.
Is this value?
With all that being said: Is there value in this stock? CVS currently trades with a price-earnings ratio of 7.5, compared to a historical average of 14. It has a respectable dividend yield of 3.8% and, until the Aetna acquisition, had 22 consecutive years of dividend increases. These have temporarily been put on hold so the company can pay down its obligations, but there is no reason to believe it won't resume the increases when and if the debt is brought under control. Overall, while there are a lot of questions hanging over CVS, there is also the potential for a recovery.
Disclosure: The author owns no stocks mentioned.
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This article first appeared on GuruFocus.
