The last month has seen the market rally off of its latest low point to mark the first positive month in about a year. Today’s big rally looks like it could be setting up a technical continuation of that bullish momentum.
That broad, bullish momentum means that a lot of stocks have been rallying off of their own yearly lows as well. If you’re looking for signals to start buying, that means that you’re starting to see more signals emerge right now, which makes for tempting reasons to go “all in” and start picking things up as quickly as you can. I think one of the things this latest rally may be dismissing is the reality that most of the risk factors that had major market indices plumbing new lows last month – high inflation, geopolitical uncertainty, rising interest rates – are still in place. To me, that means that seeing an increasing number of bullish signals is nice, but should be counterbalanced with a healthy dose of cautious, conservative optimism that reinforces the need to be selective about taking new positions and deliberate about the risk you take when you do decide the time is right to buy.
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 followed broad market momentum lower and into a clear downward trend before finding a low point in June at around $88.50. It staged a strong enough bullish rally to mark a new short-term upward trend that peaked in the middle of August at around $107 before pickup bearish momentum that hit a new bottom at around $86 in early October. Since then the stock has rallied to its latest peak at around $102, and is coming off of that low today. That looks like it could be setting up an interesting, technical buy signal in a company that occupies an interesting niche in its industry.
I think one of the elements longer-term investors should think about in CVS’ market space is the role that CVS and other pharmacy companies play in any economic environment. For the largest players in the U.S. like CVS and Walgreen’s Boots Alliance (WBA), it isn’t just about their ability to fill prescriptions – although that is a core business that is resistant to economic downturns. These are also companies that have spent the last few years actively identifying and investing in ways to evolve and innovate to stay competitive by expanding the scope of their retail locations to do more than just dispense prescriptions and sell consumer goods. Their capital investments include remodeling retail locations to provide expanded health care services and solutions. CVS, in particular was already gaining traction in leveraging its acquisition of insurer Aetna in 2018 to spur its broad transformation from just a drugstore/specialty retailer to a health care company providing a variety of services locally and affordably. They recently doubled down on their commitment to providing primary care solutions by completing an $8 billion acquisition of Signify Health, a tech company that sends care providers directly to patient homes. As a result, 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 from its Aetna merger. Could the stock also offer a good value at its current price? 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 $130.6 billion.
Earnings and Sales Growth: Over the last twelve months, earnings grew by a little over 6%, while Revenues rose by almost 10%. In the last quarter, earnings shrank by -13% while sales were flat, but positive, by 0.65%. The company’s margin profile is historically very narrow, and currently reflects the reality of rising costs as well as the company’s intensive investments in expanding into primary care; over the last twelve months Net Income was 1% of Revenues, and declined sharply to -4.21% in the last quarter.
Free Cash Flow: CVS’s free cash flow is very healthy, at nearly $19.5 billion. That marks an improvement from $15.8 billion in the quarter prior. The current number translates to an attractive Free Cash Flow Yield of about 14.9%.
Debt to Equity: CVS has a debt/equity ratio of .72. That is a generally conservative number that has dropped steadily from 1 at the beginning of 2021 as management has successfully managed to pay down a significant portion of the debt incurred to complete its merger with Aetna. In the last quarter, cash and liquid assets were about $20 billion versus $50.8 billion in long-term debt. 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 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 2.21% at the stock’s current price. It is also noteworthy that, while dividend increases had been suspended to give the company flexibility to reduce debt gradually from the Aetna merger beginning in 2020, management maintained the dividend throughout 2020 and 2021 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 $123.50 per share. That suggests the stock is undervalued, with about 24% upside from its current price. It’s also worth noting that earlier this year, this same analysis yielded a fair value target price at around $93 per share.
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 downward trend from a January peak at around $111 to its low in October at around $86. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. The stock’s rally from that low has pushed it strongly to the 61.8% retracement line where it has found immediate resistance at around $101.50, with current support expected at around $98, and around the 50% retracement line. A push above $101.50 could see upside to about $107, based on the stock’s August peak, while a drop below $98 should find next support around the 38.2% retracement line in the the $96 price area.
Near-term Keys: If you prefer to work with short-term trading strategies, a break above resistance at $101.50 could offer an attractive signal to buy the stock or work with call options with an eye on $107 as a useful exit point. A bearish signal would come from a drop below $98, with $96 providing a quick exit 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 offers a useful opportunity to consider the stock as a useful long-term, value-driven investment, even with its latest rally factored in to the equation.