Since the beginning of the year, broad market momentum has mostly stalled. Investors seem to be confronting the reality that the pandemic’s economic effects appear set to linger well into the rest of this year, even as vaccinations across the country begin to increase and new vaccine candidates appear ready to apply for emergency use authorization from the FDA. A new report yesterday from that the Congressional Budget Office predicts that unemployment won’t return to pre-pandemic levels below 4% until 2031. Perhaps more startling is additional data from the Federal Reserve indicating that workers at lower wage levels are, in fact taking the brunt of job losses, with an jobless rate above 20% for this segment, compared to about 5% for workers at the top end of the wage scale.
If you’ve been following me in this space at all, or participating in my weekly options trading webinar, you already know that CVS is a good, old friend that I’ve followed for quite some time. The pandemic has had its impact on the company’s operations, which include a significant portion of its revenues from retail sales in its stores. Those pressures are among primary reasons CVS shows some deterioration in Net Income and Free Cash Flow, and which have pushed my long-term target price from above $100 in 2020 to around $91 ahead of its next earnings report. Despite the reduction, the stock’s fair value price remains still well above the stock’s current price.
I also believe that CVS and other pharmacy companies will take on an increasingly important role throughout the rest of the year. Vaccine distribution is something that will likely extend throughout the year, and pharmacies like CVS, Walgreens Boots Alliance and others should play a big role, having already invested heavily to set up COVID testing stations that will presumably also be used to broaden vaccine distribution nationwide. How much of a financial benefit that truly translates to remains to be seen, of course, but it’s hard to argue that the expected increase in foot traffic at CVS stores won’t act as a useful headwind this year. All told, I can’t find a good reason not to take CVS seriously. The company is uniquely positioned for the current environment, not only in the pharmacy space but also with what I think is a big competitive advantage from its 2018 merger with insurer Aetna. Here are the numbers.
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 $93.5 billion.
Earnings and Sales Growth: Over the last twelve months, earnings decreased by about -10%, while Revenues rose by about 3.5%. Earnings dropped in the last quarter by -37% while sales were 2.6% higher, respectively. The company’s margin profile is very narrow, and is showing some indications of deterioration; over the last twelve months Net Income was 2.99% of Revenues, and 1.83 in the last quarter. This is a concern, but given the tailwinds I already mentioned heading into 2021, I think it is also likely to be a temporary question.
Free Cash Flow: CVS’s free cash flow is healthy, at about $12.6 billion. That does mark a decline from $13.6 billion in the quarter prior; however the current number still translates to a healthy Free Cash Flow Yield of about 14.2%.
Debt to Equity: CVS has a debt/equity ratio of .89. That is a conservative number that has dropped from 1 over the last two quarters. In the last quarter Cash and liquid assets were $12.08 billion – a little below the $12.7 billion the company reported at the beginning of 2020 – versus $61.5 billion in long-term debt. The vast majority of that debt comes from the acquisition of health insurer Aetna, however the fact that long-term debt has dropped from about $65 billion since the beginning of the year is a good reflection of the company’s success so far (with plenty of work still to go) in transitioning these disparate organizations into a larger, productive company.
Dividend: CVS pays an annual dividend of $2.00 per share, and which translates to an annual yield that of about 2.79% at the stock’s current price. It is also noteworthy that, while dividend increases have been suspended, management has maintained the dividend at current levels.
Value Proposition: 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 at about $91 per share. While that is lower than my fair value target in the last quarter, which was around $103, it still means the stock is nicely undervalued, with about 28% upside from its 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 March 2020 at around $52 to its peak in early January a little above $77. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. Throughout July, the stock hovered in a range between the 38.2% and 50% retracement lines before breaking above resistance at around $64.53 at the beginning of August. From that point, the stock set a consolidation range between $62 and $65, but broke below that level at the beginning of September. From an October low at around $56, the stock rallied strongly, with pretty wide swings from pivot low to pivot high to new, higher pivots through the beginning of January. After hitting its most recent peak at around $77.30, the stock’s bullish momentum has shifted to bearish, pushing the stock to its current level a little below $72. Immediate support should be around $70 based on pivot activity in that area in November and June 2020, with current resistance at around $74. A drop below $70 could see downside to around $67.50, while a pivot and turn off of that support level has about $4 to immediate resistance, and additional upside to about $77 if bullish momentum picks up.
Near-term Keys: If you prefer to work with short-term trading strategies, the best opportunity on the bullish side would come from bounce off of support at around $70; that could offer a good signal to buy the stock or work with call options with an eye on $74 as an exit point. A bearish signal would come from a drop below $70; in that case you could consider shorting the stock or buying put options, using $67.50 as a good bearish profit target. The stock’s value proposition remains very attractive, and even with a new earnings statement scheduled in the middle of this month, CVS continues to offer one of the best value opportunities in the stock market right now.