CVS Health Corporation (CVS)

[FUNMAN]

Agree - FUNMAN --->>> CVS Health: Just Wondering How Much More Great News We Need
Feb. 17, 2021 10:01 AM ETCVS Health Corporation (CVS)

It's up $1.25 today. I think it's still a good opportunity to buy more on the pullback.

Remember that prior to the debt ballooning after the Aetna purchase, CVS was a $90 stock. They already paid back almost $20B.

I agree with this writer's opinion. - FUNMAN

Read the article at this link to see the charts:

https://seekingalpha.com/article/4406606-cvs-health-just-wondering-how-much-great-news-need?mail_subject=cvs-cvs-health-just-wondering-how-much-more-great-news-we-need&utm_campaign=rta-stock-article&utm_content=link-0&utm_medium=email&utm_source=seeking_alpha

Summary

CVS Health reported solid fourth quarter results and the fiscal 2021 guidance is also solid.

The company also improved its balance sheet during the last 12 months.
While we should not expect dividend increases in 2021, in 2022 not only the dividend will most likely be raised, CVS will also start buying back shares again.

The stock is still deeply undervalued and trading with a discount of almost 50% in my opinion.

On Tuesday, CVS Health (CVS) reported fourth quarter results for fiscal 2020 and apparently investors did not like what they saw as the stock sold off after earnings were announced and ended the day about 5% lower. I have argued several times why I think CVS is a great investment and why I don't understand that the market is not appreciating CVS Health.



(Source: CVS Multimedia)

In the following article, I will provide an update on CVS, look at the fiscal 2020 results as well as fiscal 2021 guidance and am trying once again to understand why Wall Street does not like CVS Health.

Solid Results

Considering, that 2020 was not a great year for the economy (and that is an extreme understatement), CVS perform actually quite impressive in the last four quarters. Total revenue increased from $256.8 billion to $268.7 billion, which is reflecting an increase of 4.6%. And while in past quarters and years the acquisition of Aetna "disturbed" the growth rates, the acquisition does not have an effect on the year-over-year growth rates anymore. But not only revenue increased, operating income increased as well - from $11,987 million to $13,911 million (a growth rate of 16.1%). Diluted earnings per share increased from $5.08 in the previous year to $5.47 right now - reflecting an EPS growth of 7.7%. And net cash provided by operating activities - probably one of the most important metrics - could grow 23.5% to $15,865 million.

(Source: CVS Q4/2020 Presentation)

When looking at the different segments, all three contributed to revenue growth. While revenue from the Pharmacy Services Segment increased only 0.3%, the Retail/LTC segment could increase its sales 5.3% YoY and revenue for the Health Care Benefits Segment could increase 8.4% YoY.

And when looking at the guidance for 2021, investors should be happy. Revenue growth is expected to be between 3% and 4.5% while adjusted earnings per share are expected to be in the range between $7.39 and $7.55. What might have irritated investors (and probably caused the sell-off) was the guidance for cash flow from operations which is expected to be only in the range of $12.0 billion to $12.5 billion and therefore significantly lower than in fiscal 2020. And management is also expecting higher capital expenditures (about $3 billion), which will lead to a lower free cash flow.

(Source: CVS Q4/2020 Presentation)

Maybe some investors might be worried, that the good numbers for fiscal 2020 are only the result of COVID-19. And it is true, that COVID-19 contributed in a positive way to fiscal 2020, but according to management the positive contribution was only 22-27 cents for the full year 2020 (for GAAP as well as adjusted EPS numbers). And management is also expecting, that fiscal 2021 numbers will be similar to fiscal 2020 and therefore arguing that the good results are only due to COVID-19 is nonsense.

Improved Balance Sheet

While the good numbers are not just a result of COVID-19 and the concern of CVS only performing due to the pandemic is not making any sense, the high debt levels, which are the result of the Aetna acquisition, are certainly a major problem for CVS.

And while debt levels are still rather high, CVS could constantly improve its balance sheet during the last twelve months. When comparing the balance sheet on December 31, 2019, to the balance sheet on December 31, 2020, we see constant improvements. When looking at the asset side of the balance sheet, we see an increase in "good" assets and a decrease in "bad" assets:

Goodwill is still a major problem for CVS Health and while one year ago, the company had $79,749 million in goodwill the amount decreased a little bit to $79,552 million.

Aside from goodwill, CVS could also decrease the amount of intangible assets from $33,121 million a year ago to $31,142 million.

On the other hand, the company could increase cash and cash equivalents from $5,683 million to $7,854 million.

Additionally, the company could increase short-term investments from $2,373 million to $3,000 million and long-term investments from $17,314 million to $20,812 million.

Total assets increased from $222.4 billion to $230.7 billion and total shareholder's equity increased from $64.2 billion to $69.7 billion.
And while the asset side could increase, the liabilities side saw decreasing debt levels, which is also positive:

While short-term debt increased from $3,781 million to $5,440 million, long-term debt decreased from $64,699 million to $59,207 million.
Summing up, total debt decreased from $68,480 million to $64,647 million.

And this led also to improved financial health ratios for CVS:

On the one hand, debt-equity ratio decreased from 1.07 to 0.93 and D/E ratios below 1 are often considered as acceptable by many investors.

On the other hand, we can also compare the outstanding debt to the operating income the business can generate. When subtracting cash and cash equivalents from the total outstanding debt and compare the amount with the operating income, it would have taken 4.92 years to repay the outstanding debt one year ago. Now it would take 4.08 years to repay the outstanding debt.

Solid Dividend

Another argument I read recently is about the company's dividend. The argument was basically, that investors are avoiding CVS because the company did not increase the dividend in the last few years and that the stock won't be appreciated before management increases the dividend again.

It is true, that CVS kept the dividend only stable since 2017 and is paying a quarterly dividend of $0.50 per share. As a consequence of the Aetna acquisition, management focused on paying down the debt and in order to have as much cash as possible, dividend increases as well as the share repurchase program were suspended.

(Source: CVS Investor Relations)

For 2021, we should also not expect a dividend raise as management will not increase the dividend before the leverage ratio is around 3x. The company exited fiscal 2020 at a low 4x's leverage ratio. In my opinion, we can expect the dividend to be increased again in 2022 and the years going forward. The following slide is from the 2019 Investor Day Presentation and management is expecting to generate about $10 - $12 billion in cash annually, which can be used to enhance shareholder value (dividend and share buybacks) from 2022 going forward.

(Source: CVS Investor Day Presentation)

Right now, the company is paying about $2.6 billion annually in dividends and before the share repurchase program was suspended, CVS spent between $4 billion and $5 billion annually on share buybacks.

Let's assume CVS has $10 billion in cash to enhance shareholder value in 2022 (low end of the range), CVS could for example increase the dividend between 30% and 40% (which would be a really high dividend raise) and still have about $6.5 billion left to repurchase shares.

And if the share price should stay as low as it is right now until 2022, management should spend as much money as possible on share buybacks as I consider the stock to be extremely undervalued (we get to that point later). If we assume a similar stock price as right now and management spending $6.5 billion on share repurchases, management could buy back about 6-7% of the outstanding shares.

If investors should actually avoid CVS because the dividend has not been increased in the last few years, this would be quite foolish in my opinion. From 2022 going forward, investors can expect dividend increases again and if the share price should stay at the depressed level it is right now, management can buy back a large part of its shares and therefore increase the bottom line just by share buybacks.

Deeply Undervalued

I have mentioned several times, that CVS is extremely undervalued in my opinion. We can start by looking at simple valuation metrics. When taking diluted GAAP earnings per share of $5.47, the stock is currently trading for a P/E ratio around 13, which is not really expensive. When taking the adjusted earnings per share of $7.50 for fiscal 2020 (management is expecting a similar number for 2021), we get a P/E ratio of 9.4 right now, which has to be called extremely cheap. And when looking at the price-cash-flow ratio of the last 20 years, it seems like CVS is the cheapest it has been in a very long time (a P/FCF ratio of 6 is extremely low!).



(Source: Seeking Alpha Charting)

We can also calculate an intrinsic value by using a discount cash flow analysis. In this case, we have to make some assumptions. As a basis for 2021, we take the numbers from the company's own guidance and can expect a free cash flow of around $9 billion in 2021 (lower end of guidance). For past calculations, I always used a growth rate of 5% until perpetuity, which I will use once again. Considering that revenue will probably grow in the low-to-mid single digits and share buybacks alone could contribute in the mid-single digits to the bottom line, 5% growth seems to be absolutely realistic. When using these numbers, about 1,325 million outstanding shares (also according to guidance) and a 10% discount rate, we get an intrinsic value of $135.85 making the stock extremely undervalued at this point. And we have to call these estimates rather conservative, which is indicating an even higher intrinsic value for the stock.

Irritating Divergence

I have asked this question in the past and I will ask the question again: Why are we seeing such a huge divergence between the current stock price and my calculated intrinsic value. At least two explanations come to mind.

The first explanation seems simple and obvious and it still is often the explanation investors think about last: The intrinsic value calculation is wrong! It is not thousands or millions of market participants, that are wrong about CVS, but I made the mistake. In a time where we see overconfidence everywhere (millions of traders assume nothing could go wrong, there is no risk owning Bitcoin (COIN), there is no risk owning Tesla (TSLA) and GameStop (GME) at $300-400 was also a great investment as the WallStreetBets army cannot loose), why should I not make similar mistakes and be overconfident about CVS Health being a bargain. But if I was wrong about CVS Health, all the other Seeking Alpha authors would be wrong with me.

(Source: Seeking Alpha)

Even if we all are missing something at this point, we would be buying with a huge margin of safety and even if there would be several mistakes in my analysis, the risk of overpaying for CVS seems pretty low at this point.

A second explanation seems to be similar obvious at this point. CVS is the kind of stock, that is absolutely flying under the radar at this point and one of the boring companies, that does not get much attention. CVS is not promising to take over the world, it does not offer revolutionary new technologies, management is also not mastering the art of story-telling and is not arousing longings and dreams of exponential growth and the illusion of becoming a multi-millionaire in only a few weeks or months. For CVS starting to "rally to the moon", one would have to focus on fundamentals, look at income statements or balance sheets and appreciate a highly profitable company - but that does not seem to be a thing anymore. At this point, I can image CVS underperforming as long as this madness of extreme euphoria for meme stocks goes on, because CVS is simply not the kind of company that gets hyped (unless Elon Musk screws up with some kind of typo and accidentally tweets "CVS").

Conclusion

When looking at the kind of stocks, that are currently outperforming in this already insane market, it makes absolutely sense, that CVS is still trading at these depressed levels. CVS is a highly profitable, boring business with stable growth rates in the mid-to-high single digits and that is not the kind of stock, which is outperforming right now. When the current high-flyer stocks will collapse at some point, investors probably will refocus on what actually generates long-term returns and CVS might actually gain in value when the rest of the market will decline (just one possible scenario!). In the meantime, we are presented with a buying opportunity by Mister Market, that is apparently lasting for several years.

Disclosure: I am/we are long CVS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.