CVS Health Corporation (CVS)

[FUNMAN]

This article partly points out why I reason that after a great run this year, that I see the year-end PPS near $110

And then if more debt is paid down during 2022 and there is a December dividend increase announcement for 2023, the PPS should move up again in 2023.

Don't forget that they are closing 90 stores.

I think the Street caught up with my love affair with CVS. 

https://seekingalpha.com/article/4480411-cvs-dividend-stock-watch-after-dividend-increase?messageid=2800&utm_campaign=4480411&utm_medium=email&utm_source=seeking_alpha&utm_term=RTA+Article+Smart ;


Is CVS A Dividend Stock To Watch After The Dividend Increase?
Jan. 19, 2022 4:35 PM ETCVS Health Corporation (CVS)1 Comment3 Likes
Chuck Walston profile picture
Chuck Walston
Marketplace
Summary
After a hiatus designed to reduce debt following the Aetna acquisition, CVS recently raised its dividend payout for the first time since 2017.
The firm’s three segments generate synergies, while the PBM and Aetna provide shallow but enduring moats.
Investors fear competition from Amazon.
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Las Vegas Strip - CVS
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In Q3, CVS Health Corporation (NYSE:CVS) posted its second straight quarter of double-digit, year-over-year revenue growth. The latest earnings also marked the 14th consecutive quarter that CVS exceeded analysts' revenue expectations. Then early this week, the company raised its FY21 diluted EPS guidance and also reaffirmed FY22 adjusted EPS guidance of $8.10 to $8.30.

Those results, combined with the first increase in the dividend payout since 2016, helped to push the share price higher. CVS now trades near 52-week highs. The strong quarterly reports also reflect the integration of Aetna following the acquisition of that company in late 2018.

While many characterize CVS as a retailer, in fact, the company only derives about a third of its profits from the retail segment. Furthermore, CVS can rightfully claim that the retail business, the pharmacy benefit management (PBM) segment, and Aetna are all leaders in their respective fields.

Of course, the company still faces fierce competition, and some investors have been spooked by Amazon's entrance into the pharmacy business.

The Transformation Of CVS
In 2007, CVS acquired Caremark RX, a PBM. Then in late 2018, the company completed its acquisition of Aetna. With those deals, CVS was transformed from a retail pharmacy into a health care provider delivering an integrated health care experience. Furthermore, each segment provides operational efficiencies for the others, creating a competitive advantage over most rivals.

However, the Aetna deal cost CVS $69 billion. To buttress the balance sheet, management moved to freeze the dividend and halt stock buybacks. This led to a period of malaise in the share price. The stock dropped immediately after the deal and did not recover to pre-acquisition levels until April of this year.

The debt burden from adding Aetna pushed the company's leverage ratio to 4.7x. In turn, the major rating agencies lowered the company's debt scores. First, S&P reduced the company's debt rating from BBB+ to BBB with a stable outlook. Then Moody's followed suit, lowering its rating to Baa2 from Baa1 with a negative outlook

Since that time, management has worked diligently to pay down debt. Long term debt has been reduced by $21 billion, and the company is well along its way to reaching a goal of a low 3x leverage ratio in 2022.

Despite the added debt and the associated measures taken to restore the firm's balance sheet, the Aetna acquisition has paid off. The charts below provide evidence of the growth in revenue and EPS following the consummation of the deal.

CVS annual revenue
Macrotrends

Source: Metrics from Macrotrends & Q3 Earnings Call / Chart by author

CVS Annual EPS
Macrotrends

Source: Metrics from Macrotrends & Q3 Earnings Call / Chart by author

With 24 million members, Aetna is one of the largest insurers in the U.S. In metropolitan areas in which it is a leading provider, Aetna has a scale advantage over smaller rivals. This allows the company to offer lower costs and/or increased benefits to members. With that advantage, employers and providers are attracted to Aetna's offerings. In turn, this begets a virtuous cycle and an enduring moat.

CVS has an additional asset that strengthens its moat. The PBM operated by the company is one of the top three in the industry, along with UnitedHealth (UNH) and Cigna (CI). Combined they control nearly 80% of U.S. prescription volumes on an adjusted basis.

CVS' PBM processes approximately 2 billion, or roughly one third, of the adjusted prescriptions annually in the U.S. The scale of the PBM provides the negotiating leverage to gain discounts from drug manufacturers and pharmacies. In turn, this helps to strengthen Aetna's position as an insurer.

Prescription drug market
Statista

Source: Statista / Chart by author

The major PBM's also exhibit low churn rates from clients, with annual retention rates well above 90%.

An Ever Present Threat
In November of 2020, Amazon (AMZN) entered the pharmacy business, offering online prescription fulfillment as well as free delivery for Prime members. As one would expect, shares of CVS and Walgreens (WBA) took a dive.

Then in the middle of last year, Business Insider reported Amazon was mulling the idea of adding pharmacies to its Whole Foods stores and opening physical stores in a "handful" of locations.

While more competition is never a positive, I've reported in previous articles that contrary to conventional wisdom, Amazon does not corner the market on drug prices. Articles from Healthline and Pharmacy Checker provide evidence that Amazon's prices are often higher than that of CVS. This should come as no surprise to those that understand the advantage a PBM offers.

It should also be noted that mail-order prescriptions represent less than 20% of all prescription drug sales. Furthermore, CVS CarePass members receive free one- or two-day delivery of prescriptions as well as access to a 24/7 CVS pharmacist hotline. CVS is also using Shipt, a delivery service provider, to provide same-day prescription delivery from 6,000 locations.

I will posit that Amazon and Walmart pose far greater threats to independent pharmacies than to the major players. Rural pharmacies are being hit particularly hard. In the sixteen years leading up to 2018, over 16% of the rural pharmacies closed.

Map of pharmacies US
Kentucky Health News

Pharmacies are struggling. We're getting calls from a lot more pharmacy owners that want to sell their stores. They've had enough.

Harry Lattanzio, President of PRS Pharmacy Services

I believe it is reasonable to assume that CVS may benefit over the long term from the failure of independent pharmacies.

CVS Valuation
CVS currently trades for $106.22 per share. The 12-month average price target of the 22 analysts rating the stock is $112.95. The price target of the three analysts that rated the stock following the last earnings report is $116.66.

The company has a 5-year PEG of 2.14x, well above its average PEG of 1.44x. The forward P/E of 17.59x is nearly 3 points higher than its 5-year average P/E.

Dissecting The Dividend, And More
The current yield is 2.07%, and the payout ratio is 26.72%.

I've noted some commentators predicting that large increases in the dividend are in store. I beg to differ, and my circumspect position is based on management's pronouncements as well as the company's recent presentations.

The CEO had this to say during JP Morgan's Annual Healthcare Conference:

First, we're investing 25% to 35% in our foundational businesses, 20% will be invested in our gradually increasing dividend with growth and dividend aligned to earnings growth.

During the last earnings call, the CFO stated the dividend would grow with EPS.

A recent presentation reinforces management's guidance.

Capital generation
JP Morgan

During the latest earnings call, management provided guidance regarding expectations of growth in the coming years.

During our Investor Day in a few weeks, we look forward to sharing with you more about our path over the coming years to deliver on this ambition and to position CVS Health to generate sustainable, low double-digit adjusted EPS growth.

I think it is likely that CVS will hit the low double-digit revenue growth goal. Assuming an annual 10% dividend payout increase, we would reach a yield on a current cost basis of roughly 3% in four years.

I should add that management approved a $10 billion share repurchase plan. With the current market cap, this would result in about a 7% reduction in the share count.

Is CVS Stock A Buy, Sell, Or Hold?
To characterize CVS as a retail company is to ignore Aetna and the PBM business, which combined generate roughly two thirds of the parent company's profits. Furthermore, the PBM and Aetna provide a narrow but stable moat, and synergies exist between each of the three segments.

Management guides for sustainable EPS growth in the low double digits by 2024, and a major negative undermining investor sentiment has been removed with the resumption of share buybacks and a dividend increase. All in all, I think it reasonable to classify CVS as a very safe investment, albeit with moderate growth prospects.

I will add that companies in the health care sector tend to perform well during periods of economic uncertainty.

Last year I published two articles on CVS, and on each occasion I rated the stock as a buy. Following the article that debuted roughly a year ago, the shares beat the S&P by close to a two to one margin. The total return for CVS after my article in July is well over 4X the S&P.

I found it easy to rate the stock as a buy on those two occasions; however, I will admit that I struggled somewhat to make a decision in this instance for two reasons: a less compelling valuation and a rather modest current yield. Otherwise, I view CVS as a sound investment.

Unless I can provide a buy rating without reservation, I prefer to err on the side of caution.

Consequently, I rate CVS as a HOLD.

This article was written by

Chuck Walston profile picture
Chuck Walston
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I am a graduate of the U.S Army Ranger school and a former member of the 1st Ranger Battalion and The Old Guard (U.S Army Honor Guard.) I am a retired law enforcement officer. I have approximately 18 years experience as a retail investor.

Best of luck in your investments, Chuck
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Disclosure: I/we have a beneficial long position in the shares of CVS, CI, UNH, WBA either through stock ownership, options, or other derivatives. 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.

Additional disclosure: I have no formal training in investing. All articles are my personal perspective on a given prospective investment and should not be considered as investment advice. Due diligence should be exercised and readers should engage in additional research and analysis before making their own investment decision. All relevant risks are not covered in this article. Although I endeavor to provide accurate data, there is a possibility that I inadvertently relay inaccurate or outdated information. Readers should consider their own unique investment profile and consider seeking advice from an investment professional before making an investment decision.