The market is off to a rocky start this week. Concerns about coronavirus, which continues to spread across the world and is starting to affect corporate commentary, even found a way to filter into the crude oil market. Already under pressure due to declining demand amid massive shutdowns and quarantines starting in China, but expanding in Italy and other parts of the world, Saudi Arabia spent last weekend trying to convince Russia to cut oil production; after those discussions failed, Saudi Arabia launched a full-scale price war, pumping even more supply into the global market and forcing the price of crude oil more than -20% lower on Monday.
That shock wave rippled throughout global financial markets, including in the U.S., where a -7% circuit breaker to temporarily halt trading was triggered yesterday just minutes into the session. Some analysts have started rephrasing their commentary about coronavirus; terms like “pandemic” are starting to replace simpler words like “outbreak.” Companies, school districts, and churches are being forced to publicly adjust their operations, including keeping people home, and the Trump administration has started talking about federal intervention to mute the financial impact on workers who may be forced to stay home due to quarantine restrictions.
I write quite a bit about looking for stocks that could offer defensive positioning under uncertain market conditions. With market sentiment giving way to fear in the face of the spreading outbreak, I think one of the best places right now could be in the pharmacy space. That means stocks like CVS Health Corporation (CVS), a stock I’ve kept in my watchlist for years, and that until November of last year, had been one of the biggest winners in the stock market. The stock hasn’t been immune to market volatility; it is down a little over -14% over the last month, meaning that its performance over that period is only a little better than that of the broad market. That said, I think that as Americans deal with coronavirus – whether merely the fear, or actual treatment – CVS is the kind of business that in a position to help on multiple fronts. I think that makes it one of the smarter long-term bets from a value-oriented perspective.
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 $80.5 billion.
Earnings and Sales Growth: Over the last twelve months, earnings for CVS decreased by almost -19%, while sales rose by nearly 23%. In the last quarter, earnings were about -6% lower, while earnings increased by 3.2%. CVS’ margin profile is narrow, but stable; over the last twelve months, Net Income as a percentage of Revenues is just 2.56%, and 2.61% in the last quarter. The trailing twelve month number also marks a reversal from just about a year ago, when Net Income was actually negative.
Free Cash Flow: CVS’s free cash flow is healthy and improving, at about $10.3 billion over the last twelve months (it was around $8.4 billion in April of 2019). That translates to a Free Cash Flow Yield of 12.4%, which is also a useful improvement from early 2019 when it was 7.28%.
Debt to Equity: CVS has a debt/equity ratio of 1.3. 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 end of 2018 when its merger with insurer Aetna was first announced. Total long-term debt is $83.6 billion, while cash and liquid assets are about $8.05 billion (up from $6.5 billion in March of 2019). 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. Management has also suspended dividend increases 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 3.26%.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target above $93 per share. That means the stock is trading at a massive discount, with 55% upside from the stock’s current price.
Technical Profile
Here’s a look at CVS’ latest technical chart.
Current Price Action/Trends and Pivots: The diagonal red line marks the stock’s upward trend from May to November of last year. After peaking around $77, the stock tapered slowly lower until last month, when the broad market started picking up volatility. The stock has also been highly volatile from that point, dropping more than -14%, but despite its current downward momentum, the stock is nearing support around $57.50. That could offer an attractive level for the stock to start to stabilize. Near-term resistance is around $65 (the stock’s most recent pivot high), which means that if momentum can shift to bullish terms, the stock has some interesting short-term upside. If support at $57.50 doesn’t hold, the stock could easily test its 52-week low in the $52 price area.
Near-term Keys: If the stock reverses upward, and you don’t mind being aggressive, you could consider buying the stock or working with call options, with an eye on $65 as a profit target. A break below $57.50 would be a good signal to consider shorting the stock or working with put options, with $52 as a useful exit point on a bearish trade. The stock’s value proposition, on the other hand, is extremely attractive, and from a long-term perspective, I think offers one of the best value opportunities in the stock market right now and could be a smart investment to think about making right now.