CVS Stock Will Come Back Strong, but Be Wary of Upcoming Earnings
Today, I’d like to discuss the short- and long-term outlook for CVS Health (NYSE:CVS), the integrated pharmacy health care company. CVS stock has been in a multi-year downtrend since July 2015, when it tapped an all-time high of $113.65.
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Year-to-date, CVS stock which has missed the broader market rally in 2019, is down 13% and currently hovers around $57.5.
When I look for companies to add to a diversified portfolio, I look for growing revenue, net income, and dividends, as these factors add favorably to the investment thesis.
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Therefore, I regard CVS a good long-term pick. However, as it gets ready to report earnings on Aug.7, there might be some short-term price weakness in the stock that investors should anticipate.
What to Expect from CVS Stock Earnings
When CVS Health reports its next earnings, investors will analyze its three main segments:
Pharmacy Services (over 70% of sales come from it);
Retail/LTC;
Health Care Benefits (recently established).
These segments provide CVS with diversified sources of revenue, earnings and cash flow. In May, CVS Health reported better-than-expected Q1 earnings.
Revenue grew 34.8% to $61.6 billion. Adjusted operating income increased by 56.8% to $3.6 billion. Wall Street mostly credited this growth and improved metrics with the acquisition of Aetna, which CVS Health completed in November. As a side note, in Nov. 2018, CVS stock traded at about $80 per share. Aetna is the third-largest U.S. health insurance company by membership and revenue.
The Pharmacy Services segment provides pharmacy benefit management services to employers, health plans, and government employee groups as well as government-sponsored programs. Revenues last quarter were up 3.1% year-over-year (YoY).
The Retail/LTC segment fulfills prescriptions for medications, provides patient care programs, sells general merchandise, and offers health care services through walk-in clinics. Another way to think about this segment is the two parts to a CVS store, that is, the front retail section and the rear pharmacy section. Revenues rose 3.3% YoY.
With the acquisition of Aetna, CVS Health established a new Health Care Benefits segment, which would be the equivalent of the former Aetna Health Care segment. This segment now provides a full range of insured and self-insured medical, pharmacy, dental and behavioral health products and services.
CVS Health’s quarterly report showed that adjusted earnings per share grew 9% to $1.62. Management also gave an improved outlook for the rest of the year — a number highly cheered by investors. The company’s size and presence, as well as its proactive management, are likely to increase the group’s ability to grow revenue and earnings in future quarters, too.
CVS Stock Has Long-Term Strengths
Most consumers know CVS Health as one of the largest pharmacies in the U.S. Yet with its Aetna health insurance unit, its Caremark PBM, and retail pharmacies, the group has also become a vertically integrated stock, providing a wide range of services and products.
With almost 10,000 pharmacies in the U.S., the company operates a growing and profitable pharmacy segment, filling over a billion prescriptions per year. Going forward, CVS Health is expected to provide medical services within these store locations.
At present, there are 1,100 walk-in Minute Clinics within those pharmacies, staffed by nurses and physician assistants. Minute Clinics, which started in 2000, have become the largest operator of retail health clinics, seeing patients for minor treatments, like flu shots, as well as advice on topics like weight loss and smoking cessation.
In other words, there is further potential to combine CVS’s current dense local footprint with the health care benefits and services offered by Aetna.
We all get sick occasionally or have friends and relatives who may need treatments for chronic illnesses. Moreover, according to the Census Bureau, in about two decades the elderly will outnumber children for the first time in U.S. history. That means the country will need more health care facilities and drugs. Therefore, I expect the pharmacy section to continue to contribute strongly to CVS Healthcare bottom line.
For CVS Health, 2019 will likely be remembered as a year of transition as management integrates the two companies and clarifies its focus on how to achieve the sustainable growth the group hopes to achieve. There are still questions to which investors do not have the full answers. And the CVS stock price action has been reflecting that uncertainty.
With 2020 onward, though, investing in CVS may indeed become a healthy long-term supplement for most portfolios. I find the company to be well-positioned for the country’s evolving demographics and the potential transformation of the U.S. health care system. Therefore it will likely continue to see growth in its fundamentals.
What Could Derail CVS in the Short Term?
Despite the strength in the recent earnings results, many investors are still wondering whether CVS Health might have overpaid for in the $69 billion Aetna deal announced in December 2017. In other words, investor sentiment remains weak, or shaky at best.
Although analysts are hopeful that this merger will also create opportunities for cost savings, Wall Street is not exactly sure as to where the full synergies of the combined group will be.
Furthermore, the acquisition of health-insurance giant Aetna is adding a substantial amount of debt to CVS’s balance sheet. As of Q1, CVS’ net debt, which includes both short and long-term debt, was $65 billion. In March 2018, investors showed a healthy appetite for CVS’s $40 billion M&A bonds.
Yet, many analysts regard the amount of long-term debt as quite risky. Therefore, potential investors may want to pay close attention to the debt levels in future earnings results.
For CVS Health, its pharmacy benefits management (PBM) services have always been very important. If CVS cannot get its current PBM customers who are insured elsewhere to switch to Aetna, then investors may get worried about future earnings and decide to step on the sidelines.
Or if CVS’s PBM business cannot achieve greater negotiating power and benefits with drug companies, as management is hoping that the merger will enable the group to do, then CVS stock may become a bitter pill to swallow.
Finally, a potential economic slowdown or increased competition in the healthcare segment, as well as potential regulatory changes in the U.S., could cause CVS stock to underperform in the rest of the year or 2020.
Should Investors Buy CVS Health Stock in July?
Long-term, I am bullish on the outlook for CVS Health stock as I believe management will take the right steps to achieve acquisition synergies. Now, the group has a wider reach in the healthcare industry.
Furthermore, as debt levels decline, interest expenses will also decrease. As a result, CVS stock’s earnings are likely to get on the road to a steady growth trajectory.
Yet due to the decline in price since 2015, CVS Health stock has a not-so-pretty long-term technical picture. In the long-run, CVS stock needs to build a base again before a long-term sustained leg up can occur.
On the other hand, the short-term technical chart has recently been improving, and CVS is stabilizing between $52.5 and $57.5.
If you aren’t already long CVS stock, you may want to remain on the sidelines until the earnings report as near-term trading is likely to be choppy. Or you may also consider buying covered calls in conjunction with going long on CVS Health stock.
In general, selling covered calls on dividend-paying stocks, like CVS, would enable long-term investors to weather further volatility as well as create extra portfolio yield. If you would like to find more about the strategy you may want to talk to your investment advisor or broker.
The internet also offers plenty of examples of how to execute covered calls. Most investment advisors would regard a covered call as a conservative strategy that requires no extra margin.
Investor Takeaway
After the next earnings call in August, if you still believe in the bull case for CVS Health stock, you may consider buying into the shares. Long-term shareholders would also enjoy a current dividend yield of 3.5%.
As of this writing, Tezcan Gecgil holds CVS covered calls (July 19 expiry).
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