I tend to take most of the information I get from news media with a large grain of salt. That is especially true of market media outlets, which have so much information to try to report about on a daily basis that they really can’t do much more than talk about whatever happens to be generating the most buzz at the moment. Even with that mind, I do still make sure to take some time each day to get a sense of what that common commentary is – because where I find often find the best opportunities comes in identifying gaps in what popular media, analysts, and so investors in general are paying attention to.
Looking for value in the stock market is something that I contend you can do in any market condition, but it is something that tends to get dismissed by most pundits simply because it isn’t very sexy. Names like Tesla, Netflix, and Amazon practically never make the value list because the massive amount of attention the market has given them for years has kept their stocks priced at levels that makes them impractical to consider strictly on the basis of value. Instead, current market conditions means that looking for value means dealing with industries that most analysts and investors are looking past as practically everybody is looking ahead to the point in time that we can finally put the pandemic behind us and start talking about non-pandemic-related questions about economic growth. The industries that I am seeing the best valuations right now are generally defensive ones, such as Food Products and Health Care – including big Pharma – and more cyclical, even volatile sectors such as Energy.
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. Since my last review on this stock, the company has released a new earnings report, which shows continued pressure on Net Income that I believe is mostly a reflection of this year’s health crisis-driven pressures. The short-term result is that my long-term target price has dropped a bit from above $100 around the mid point of last year to around $91, but that is still well above the stock’s current price.
Consider that a continued effort and push to approve new COVID vaccines and make more supply available has some health experts forecasting herd immunity could be reached in the U.S. by mid-year, and the role that CVS and other pharmacy companies will take as places the public at large would be able to get vaccinated. 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 as 2021 gets rolling. This is a company that was already gaining traction in its broad transformation from just a drugstore/specialty retailer to a health care company providing a variety of services locally and affordably, and it is hard 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 competitors owing to its 2018 merger with insurer Aetna. If this stock isn’t already on your radar, it really should be.
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 $90.7 billion.
Earnings and Sales Growth: Over the last twelve months, earnings decreased by about -25%, while Revenues rose by about 4%. Earnings dropped in the last quarter by -21.69% while sales were 3.73% higher, respectively. The company’s margin profile is very narrow, and is showing some indications of weakness; over the last twelve months Net Income was 2.67% of Revenues, and 1.4% 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 $13.4 billion. That does mark a decline from $13.6 billion in June of last year; however the current number still translates to a healthy Free Cash Flow Yield of about 14.81% and marks an overall increase from $10.4 billion at the beginning of 2020.
Debt to Equity: CVS has a debt/equity ratio of .85. That is a conservative number that has dropped from 1 over the last three quarters. In the last quarter Cash and liquid assets were $10.8 billion versus $59.2 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 2020 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 2.89% at the stock’s current price. It is also noteworthy that, while dividend increases have been suspended (not because of COVID, but to give the company flexibility to reduce debt gradually from the Aetna merger), 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 earlier last year, which was around $103, it still means the stock is nicely undervalued, with about 32% 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 to its peak in early January at around $77. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. The stock saw a nice overall jump in price from its bear market low at around $52 to its $77 peak, albeit with quite a bit of volatility along the way. Since the beginning of the year, however, the stock has faded back from that high and is currently about -10% off of that mark. It does show strong support at around $67.50 based on the 38.2% retracement line and a pivot low a little above that point at the end of last week. Immediate resistance is at around $71.50, with short-term room to about $75 if the stock can break above that level. A drop below support at $67.50 should find next support between $66.50 and $65.50 based on plenty of pivot activity in that region in November and the summer months of 2020 as well as the 50% retracement line.
Near-term Keys: If you prefer to work with short-term trading strategies, the best opportunity on the bullish side would come from break above resistance at $71.50; that would be a good signal to buy the stock or work with call options with an eye on $75 as a useful exit point. A bearish signal would come from a drop below $67.50, but keep in mind that support is very close by, with only about $2 of downside in the near term. From the standpoint of value and long-term opportunity, the stock’s bargain proposition remains very attractive. I think CVS continues to offer one of the best value opportunities in the stock market right now.