Over the last four years, one of the most disappointing stocks in the market unquestionably has to CVS Health Corp (CVS). The stock hit an all-time high in July of 2015 at around $113 per share, but has steadily declined from that point to its lowest point since 2013 a little below $52 per share. That downward trend would unquestionably have chased away any growth-oriented investor, but it has also translated to a value proposition that has become more and more compelling the longer the downward trend has lasted.
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CVS is a good example of the challenge that often faces a value-oriented investor. The traditional method behind value investing suggests that timing, or a stock’s current trend, is unimportant when compared to whether the company’s business is worth more than where the market is currently pricing the stock. The problem with that principle is that every investor, no matter how educated or experienced we may be, is an emotional animal, and that means that it is hard to hold onto a stock in the face of an extended, steep decline in price. As recently as two years ago, the stock had dropped to the mid-$80 range, and had begun to offer the first indication of opportunity as a strong value-oriented investment, but as any investor who bought the stock at that time can attest, watching the stock continue to decline until earlier this year to a low at nearly $50 would naturally make you question the wisdom of your decision.
Throughout the decline I’ve described, CVS’ fundamental profile has remained strong, which has ultimately meant that the longer the downward trend lasted, the better the value argument became. The market appears to finally be starting to get the hint; beginning in May of this year, the stock has rallied nearly 23% from that low, and has finally developed what appears to be a solid intermediate upward trend that could be poised to continue into a long-term trend.
Among the bearish pressures the stock has faced this year has been concern that the merger it completed in November of 2018 with insurer Aetna came at too large a price. CVS took on a massive amount of debt, which also forced the company to suspend its share buyback program until it lowers its debt load.
In the long run, management and most industry experts expect that the combination of one of the largest and most profitable pharmacy companies with one of the biggest insurers in the country will be able to navigate the transition involved in the integration of two distinctly separate, but complementary businesses; but there appears to be a lot of questions about when that success will translate to the stock price. The stock’s fundamental measurements are solid, however, and appear to be improving, suggesting that management’s strategy is working. Despite the stock’s increase in price over the last few months, CVS’ value proposition remains very positive in the long-term, suggesting that the stock could be poised for a new, extended upward run.
Fundamental and Value Profile
CVS Health Corporation, together with its subsidiaries, is an integrated pharmacy healthcare company. The Company provides pharmacy care for the senior community through Omnicare, Inc. (Omnicare) and Omnicare’s long-term care (LTC) operations, which include distribution of pharmaceuticals, related pharmacy consulting and other ancillary services to chronic care facilities and other care settings. It operates through three segments: Pharmacy Services, Retail/LTC and Corporate. The Pharmacy Services Segment provides a range of pharmacy benefit management (PBM) solutions to its clients. As of December 31, 2016, the Retail/LTC Segment included 9,709 retail locations (of which 7,980 were its stores that operated a pharmacy and 1,674 were its pharmacies located within Target Corporation (Target) stores), its online retail pharmacy Websites, CVS.com, Navarro.com and Onofre.com.br, 38 onsite pharmacy stores, its long-term care pharmacy operations and its retail healthcare clinics. CVS has a market cap of $81 billion. Aetna Inc. is a diversified healthcare benefits company. The Company operates through three segments: Health Care, Group Insurance and Large Case Pensions. It offers a range of traditional, voluntary and consumer-directed health insurance products and related services, including medical, pharmacy, dental, behavioral health, group life and disability plans, medical management capabilities, Medicaid healthcare management services, Medicare Advantage and Medicare Supplement plans, workers’ compensation administrative services and health information technology (HIT) products and services. The Health Care segment consists of medical, pharmacy benefit management services, dental, behavioral health and vision plans offered on both an Insured basis and an employer-funded basis, and emerging businesses products and services. The Group Insurance segment includes group life insurance and group disability products. Its products are offered on an Insured basis. CVS has a market cap of $82.5 billion.
Earnings and Sales Growth: Over the last twelve months, earnings for CVS increased by almost 12%, while sales increased nearly 36%. In the last quarter, earnings growth was about 16.5%, while earnings increased by 2.9%. CVS’ margin profile was narrow before the merger, and it continues to be so; over the last twelve months, Net Income as a percentage of Revenues is just 1.9%, but improved to 3.05% in the last quarter. The trailing twelve month number also marks a reversal from just a couple of quarters ago, when Net Income was actually negative.
Free Cash Flow: CVS’s free cash flow is healthy and improving, at about $8.44 billion over the last twelve months (it was around $4.3 billion in the first quarter of 2019). That translates to a Free Cash Flow Yield of 10.13%, which is also a useful improvement from earlier this year when it was 7.28%.
Debt to Equity: CVS has a debt/equity ratio of 1.39. This is higher than I usually prefer to see, but is primarily attributable to the massive increase in debt the company preemptively took on at the beginning of the year when the merger was first announced. Total long-term debt is $85.7 billion, while cash and liquid assets are about $8.5 billion (up from $6.5 billion in March of this year). By standard measurements, the company’s liquidity comes into question; however CVS has also laid out an aggressive debt reduction program that they expect will lower the total debt the combined company will be working with to much more conservative levels early in 2020. As previously mentioned, they’ve also suspended their dividend increase and share repurchase programs for the time being while they work on debt reduction.
Dividend: CVS pays an annual dividend of $2.00 per share. At the stock’s current price, that translates to an attractive dividend yield of about 3.15%.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for CVS is $47.37 — a drop from $57.46 two quarters ago. This is an element of the stock’s fundamental and value profile that is showing an unusual level of volatility and variability and that I take as evidence that the company is still dealing with post-merger integration issues. Even so, at CVS’s current price, that translates to a Price/Book ratio of 1.33. The stock’s historical average is 2.5, which suggests the stock is still undervalued by at least half and projects a long-term target at around $119. That number lines up with the stock’s all-time highs around $113 and that were last seen in mid-2015.
Here’s a look at CVS’ latest technical chart.
Current Price Action/Trends and Pivots: The chart above clearly shows the stock’s decline from about $84 in October 2018 to its bottom at about $52. The stock has picked up some interesting bullish momentum since late June, rallying near to the 38.2% Fibonacci retracement line at around $64. It is currently a bit below that level, which suggests that a break above $64 could give the stock some useful short-term momentum to push to somewhere between $70 and $71.50, based on previous pivots in late 2018 and earlier this year. Current support is around $62, with further support if the stock drops below that level in the $59 price area.
Near-term Keys: The stock’s current trend is clearly moving upward, and appears to be building bullish momentum. The value proposition is very attractive, and I think that is more than sufficient reason to suggest that this stock could be one of the best long-term bets in the market right now. If you prefer to work with short-term trading strategies, a push above $64 could offer an interesting opportunity to buy the stock or to work with call options with an eyes on the stock’s previous peaks around $70 as an exit target. On the other hand, if the stock drops below $62, you might consider shorting the stock, or working with put options, with an eye on the $59 price level as a short-term target to for a bearish momentum trade.
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