CVS is down more than -27% year to date. Where is its bargain price?

The stock market has had a tumultuous, but mostly positive run so far in 2023.

Whether that run continues, of course depends on a variety of factors, including whether interest rates will finally begin to level off, or maybe even begin to go down, which naturally depends on the wide range of inflationary conditions that are still seen across the globe begin to fade. For investors, I think that means that finding useful investing opportunities remains a matter of focusing on areas of the economy that may be less sensitive to the effect of high interest rates, and where demand will remain high even if the economy does begin to slow down.

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 2022, rising from about $68 at the beginning of March 2021 to a peak in early February 2022 at around $111. From that high, the stock followed broad market momentum lower and into a clear downward trend before finding a low point last October at around $86. It staged a strong enough bullish rally to mark a new short-term upward trend that peaked in the middle of December at around $104 before dropping back into its bearish trend, where it’s latest low point occurred just about a week ago at around $66.50. That’s a big drop that would have most growth-investors running for the exits – but the ironic thing from my contrarian, value-based perspective is that the fundamentals are much stronger than the stock’s current trend suggests.

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. Late last year, they 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, I find it 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. With some very interesting fundamental strengths working in the company’s favor right now, I think the latest drop could just make the stock’s value proposition look even better than normal right now.

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 $86.5 billion.

Earnings and Sales Growth: Over the last twelve months, earnings growth was flat, but negative by -.9%, while Revenues rose by 11%. In the last quarter, earnings were 10.55% higher, while sales grew by 1.71%. The company’s margin profile is historically very narrow; over the last twelve months Net Income was 1.19% of Revenues, and strengthened to 2.5% in the last quarter.

Free Cash Flow: CVS’s free cash flow is very healthy, at nearly $17.4 billion. That marks an improvement from $13.45 billion in the quarter prior, and confirms the strength in the company’s operating margins I just described. The current number translates to an attractive Free Cash Flow Yield of 20.05%.

Debt to Equity: CVS has a debt/equity ratio of .79. 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 $17.8 billion versus $56.45 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 $2.42 per share, and which translates to an annual yield of about 3.58% 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. They also announced the first increase, along with the implementation of a new stock buyback program at the beginning of 2022, and increased the dividend again at the start of this year from $2.20 per share. An increasing dividend is a strong confirmation of management’s confidence.

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 $90 per share. That suggests the stock is significantly 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 downward trend from a peak in July of last year at around $107 to its latest low, reached in the last week at around $66.50. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. The stock’s downward trend is clear, and only appears to be extending itself right now. Current support is at that latest low at $66.50, while immediate resistance is around $70. A drop below $66.50 could see the stock drop to about $63, using the current distance between support and resistance as a benchmark. A push above $70 should find next resistance at around $73 per share.

Near-term Keys: If you prefer to work with short-term trading strategies, a break below $66.50 would be a good signal to consider shorting the stock or buying put options, with a useful profit target at around $63 on a bearish trade. A bullish trade would be very aggressive considering the strength of the downward trend right now, however if you aren’t afraid to be speculative, a push above $70 could be a signal to think about buying the stock or working with call options, with $73 acting as a smart profit target for a short-term bullish trade. From the standpoint of value and long-term opportunity, the stock offers a very interesting bargain proposition to consider the stock as a long-term, value-driven investment, with improving fundamental strength serving to bolster the value argument even more.