Looking for value in the stock market is something that I have found can be done in any market condition, but it is something that tends to get dismissed by most pundits simply because it isn’t very sexy. Popular, “buzzy” names like Tesla, Netflix, and Amazon practically never pass the value test because the massive amount of attention the market has given them for years has kept their stocks priced at levels that makes them impractical for an objective analysis based strictly on value. More often than not, looking for value means passing over the names and pockets of the market that get the most attention from media and the general investing public to dig into the industries that everyone else tends to overlook.
If you’ve been following me in this space at all, or participating in my weekly options trading webinar, you already know that CVS Health (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 a continuation of useful increase in some of my favorite fundamental metrics and pressure on others. The stock itself has been a star performer for the past year, rising from about $68 at the beginning of March 2021 to a peak in early February at around $111. From that high, the stock drifted a bit lower, but while the rest of the market has been beaten down amid inflation and interest rate fears, and then compounded by Russia’s invasion of Ukraine, CVS has actually increased in price by about 4% in the last three weeks.
There are just a few things that tend to really terrify the market, and the last month has seen two of the big ones. War has the potential to impact the world on multiple fronts, of course, and we are seeing some of that play out in the human cost in Ukraine as well as the economic impact of the West’s combined efforts to isolate Russia using sanctions. Inflation is another, because that does raise the spectre of interest rate hikes. This week the Fed approved the first increase, of 25 basis points, and is forecasting additional increases following each of the six remaining meetings they have scheduled through the end of the year. Altogether, global political uncertainty at the same time that interest rates are rising makes for a potentially toxic mix.
I think one of the takeaways investors can take related to the pandemic, and that is also element that mitigates some of the broad market uncertainty and downside risk in CVS’ market space is that the role CVS and other pharmacy companies will continue to play. 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. I believe 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 over the rest of its industry owing to its 2018 merger with insurer Aetna.
The stock’s long-term trend can be interpreted as a sign that the stock’s latest drop and turn back to the upside is just another, classic opportunity to “buy the dip” and keep riding the trend higher; but it is also very possible that the larger issues that are starting to overshadow the market present an increasing risk that the opposite is true, and that since all trends are finite and will inevitably reverse back against themselves, CVS could still be at a critical tipping point where the risk doesn’t justify the potential reward. The trend also naturally begs the question of where the stock’s useful, value-oriented price should be. Let’s dig in to find out.
Fundamental and Value Profile
CVS Health Corporation, together with its subsidiaries, is a health services company. The Company operates through four segments: Pharmacy Services, Retail/LTC, Health Care Benefits and Corporate/Other. The Pharmacy Services segment provides a range of pharmacy benefit management (PBM) solutions, including plan design offerings and administration, retail pharmacy network management services, mail order pharmacy, specialty pharmacy, clinical services, disease management services and medical spend management. The Retail/LTC segment sells prescription drugs and a range of health and wellness products and general merchandise. Its Health Care Benefits segment offers a range of traditional, voluntary and consumer-directed health insurance products and related services. It has approximately 9,900 retail locations, over 1,100 walk-in medical clinics, a pharmacy benefits manager with approximately 105 million plan members, specialty pharmacy services and a senior pharmacy care business. CVS has a market cap of $141.3 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased by about 52.3%, while Revenues rose by a little over 10%. Earnings were flat, but positive in the last quarter by 0.51% while sales were about 3.8% higher. The company’s margin profile is very narrow, and is showing some weakness; over the last twelve months Net Income was 2.71% of Revenues, and slipped to 1.7% in the last quarter.
Free Cash Flow: CVS’s free cash flow is very healthy, at nearly $15.74 billion. That marks an improvement from $12.9 billion a year ago, and a little under $15.2 billion in the quarter prior. The current number translates to an attractive Free Cash Flow Yield of about 11.44%.
Debt to Equity: CVS has a debt/equity ratio of .69. That is a generally conservative number that has dropped steadily from 1 a little over a year ago. In the last quarter Cash and liquid assets were about $12.5 billion (compared to $10.1 billion two quarters ago) versus $51.9 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, with about $5 billion of that coming in the last quarter, 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 $2.20 per share, and which translates to an annual yield that of about 2.11% at the stock’s current price. It is also noteworthy that, while dividend increases were been suspended (not because of COVID, but to give the company flexibility to reduce debt gradually from the Aetna merger) beginning in 2020, management maintained the dividend throughout the pandemic and announced the first increase, along with a new stock buyback program after the latest announcement.
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 $92 per share. That suggests the stock is close overvalued, with -14% downside from its current price, and a practical discount price at $73.50.
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 February 2021 to its peak in February at around $111. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. The stock found a bottom at around $102 to establish current support at the start of March and has been building gradual, upward momentum from that point. Immediate resistance is at the stock’s peak this week at around $107, with upside to about $111 if the stock pushes above that point. A drop below $102 should find next support at around $101, but if bearish momentum accelerates it could fall all the way to the 38.2% retracement at around $96 before finding additional support.
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 $107; that would be a good signal to buy the stock or work with call options with an eye on $111 as a useful exit point. A bearish signal would come from a drop below $101, with $96 providing a useful target no matter whether you choose to short the stock or buy put options. From the standpoint of value and long-term opportunity, the stock’s yearlong upward trend has outpaced the company’s fundamental strength, and the recent pullback hasn’t come back far enough to make the stock a useful value opportunity. For practical purposes, the stock would need to fall to around $73.50 before I think a compelling, value-based argument can be made.