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.
The stock was a star performer in 2021 and the early part of this 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 has followed broad market momentum lower and now sitting about -15.5% below that February high point.
There are just a few things that tend to really terrify the market, and the last few months have seen two of the big ones come front and center to everybody’s attention. War brings with it the potential to impact the world on multiple fronts, of course, and we have certainly see that play out, not only 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 rising inflation always brings the spectre of increasing interest rate with it. The Fed has approved two increases, of 25 and 50 basis points, respectively, and is forecasting additional increases following each of the remaining meetings they have scheduled through the end of the year. Rising interest rates prompt fear of recessionary economic conditions and all of the localized difficulties that come with them. Put all of these elements together, and it shouldn’t be surprising that what you get is a toxic mix that has all of the major stock market indices at or on the verge of legitimate bear market conditions.
I think one of the takeaways investors can take related to the pandemic, and that is also an element that mitigates some of the broad market uncertainty and downside risk in CVS’ market space is the role that 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 may be 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 remains at a critical tipping point where the risk may not justify the potential reward. The trend since February 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 $122.8 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased by 8.82%, while Revenues rose by 11.19%. In the last quarter, earnings grew by 12.12% while sales were flat, but positive, by 0.29%. The company’s margin profile is historically very narrow; over the last twelve months Net Income was 2.67% of Revenues, and increased to 3.01% in the last quarter.
Free Cash Flow: CVS’s free cash flow is very healthy, at nearly $16.2 billion. That marks an improvement from $11.6 billion a year ago, and $15.7 billion in the quarter prior. The current number translates to an attractive Free Cash Flow Yield of about 13.14%.
Debt to Equity: CVS has a debt/equity ratio of .70. That is a generally conservative number that has dropped steadily from 1 at the beginning of 2021. In the last quarter, cash and liquid assets were about $11.3 billion versus $52 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 $2.20 per share, and which translates to an annual yield that of about 2.34% 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 the implementation of a new stock buyback program at the beginning of this year.
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 $93.50 per share. That suggests the stock is fairly valued, with a practical discount price at about $75.
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 an August 2021 low at around $79 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 has dropped into an intermediate-term downward trend from its February high, with momentum picking up significantly in the last month. Yesterday, the market’s sell off forced the stock below expected support at around $95, marking immediate resistance at that point. Current support should lie at around $91.50, where the 61.8% retracement line sits. A drop below $91.50 could see the stock fall to about $89 before finding next support, while a push above $95 should have upside to about $99 before finding next resistance.
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 $95; that would be a good signal to buy the stock or work with call options with an eye on $99 as a useful exit point. A bearish signal would come from a drop below $91.50, with $89 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 recent drop, while steep has only brought the stock to its fair value, so it can’t be called a useful value-driven opportunity yet. For practical purposes, the stock would need to fall to around $75 before I think a compelling, value-based argument can be made.