CVS Health Corporation (CVS)

[FUNMAN]

A CVS article to make you smile CVS: Growing With Larger Healthcare Market And Telehealth

Jan. 28, 2022 9:46 AM ET

https://seekingalpha.com/article/4482444-cvs-growing-larger-healthcare-market-telehealth-stock-buy?mailingid=26518489&messageid=2800&serial=26518489.4944&utm_campaign=rta-stock-article&utm_medium=email&utm_source=seeking_alpha&utm_term=26518489.4944

Summary

* CVS is undervalued based on current S&P ratios.

* CVS has plenty of growth ahead.

* CVS has an interesting partnership with Teladoc that gets it access to a nice, growing segment of the healthcare market.

Since I last covered CVS (NYSE:CVS), anyone sharing in my advice would have seen gains of 80% or more. This "value" name has had great growth over the last year or so - and I believe they still have many opportunities ahead. However, it seemed important to choose if it was still worth the buy rating for anyone who is newer to the CVS name.

CVS is no longer the once boring corner drugstore as it has officially moved into the larger healthcare market. It leveraged itself to healthcare - in a move many did not like - when it purchased Aetna years ago for $69 Billion. Loaded with debt, but having plenty of income, the company was ignored by investors until rather recently when the market started noticing that it was executing its strategy… and doing it well.

The debt burden has mostly been managed as CVS has paid down $21 Billion and reached its stated goal, a leverage ratio under 3x, roughly a year early. (The dividend was halted at $0.50 per share per quarter for the entire time to assist in paying down the debt quicker. It has since had an announced 10% dividend increase, likely the first of many such yearly announcements.) Stock pickers moved on and missed the opportunity of a company with powerful earnings, including missing the growing healthcare company it was creating. Value investors who saw earnings knew that if CVS would stick to the plan, things could work out and many holders have made out well with gains of 50-100% over mere years. (Not bad at all for a "value stock.") CVS is still a value-priced company, but does it have enough growth ahead?

The Basic Business Model
CVS has created a growing, near-whole healthcare company. CVS's Caremark division provides roughly one-third of company revenues while working behind the scenes with health insurers as a pharmacy. (Technically a Pharmacy Benefit Manager, or PBM.) They are using the 'boring drugstore' PBM by leveraging what is the nation's largest pharmacy service - more technically the highest prescription drug market - to deliver medicines to anyone and everyone who will use the service.

With the purchase of Aetna, CVS gained access to health benefits and managed care for over 23 million members, which made them the third-largest health insurer in the U.S. This is a competitive market, and Anthem (NYSE:ANTM) and UnitedHealth (NYSE:UNH) have a rather large lead, but continually adding services and more convenient access centers should assist CVS in growing this business.

Then Aetna President, Karen Lynch, became the President and CEO of CVS last year. With her Aetna background, she rightfully seems highly focused on increasing income via healthcare coverage and offerings. The previous President, Mr. Merlo, and the board even adjusted the name from CVS/Caremark to CVS Health, further showing what they are focused on.

This is really the reason for CVS "Minute Clinics" and "HealthHubs". CVS is pushing more and more services into 'the corner drugstore' and revamping layouts to create treatment centers for simpler-yet-common chronic diseases, like sleep apnea or diabetes, as well as pushing into mental and behavioral health. Pairing with Teladoc (TDOC) and using its services for virtual visits, CVS is leveraging their technology to be even more convenient to consumers all over.

The Amazon Threat
Amazon (AMZN) is attacking the healthcare market leveraging its massive online presence and distribution warehouses in strategic areas. Focusing on quick shipping to most locations, Amazon has become a get anything-and-everything online shop with great brand awareness. Amazon sees the growth in the healthcare and prescription markets and has been trying to enter and gain share since its 2018 acquisition of PillPack, but consumers still need a doctor and prescription to use this service.

Amazon, Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) and JPMorgan all paired together to tackle the healthcare cost issue, creating a service known as Haven, and came up lacking - with all eventually cancelling this venture. Amazon still sees dollar signs and is undeterred from the healthcare market and is now launching - or maybe you could say rebranding as - AmazonCare in order to assist folks in getting a doctor visit and prescription online. I don't deny that any entrance by Amazon is significant; however, they have a tough haul trying to gain employers and consumers one at a time. CVS already has many of these employer and consumer relationships. But Prime members could possibly be swayed by the Amazon effect.

Not to be left out, Walmart (WMT) purchased MeMD and has benefitted from its store pharmacies to bring more things to more customers. The big retail stores are not as numerous as CVS, however, they do have half the reach and are doing everything they can to make their stores a one-stop-shop. The larger store focus does create other challenges, but Walmart has faced challenges before.

CVS's Angle of Attack
CVS is attacking the same overall healthcare market, a massive and growing Total Addressable Market (TAM), but from a different angle as the above companies. It is also using different tactics from the larger medical insurance companies, UnitedHealth and Anthem, as it looks for more market share - and profits. As mentioned in previous articles here and here, CVS is leveraging its 9,900 stores and distribution centers to get closer to people. Stats show that roughly 80% of all U.S. citizens are less than 10 miles from a CVS store. This gives CVS a unique proximity to consumers, a convenience factor if you will, as their ubiquitous "corner stores" reach into nearly every city.

CVS stores, roughly 1,500 by end of 2021, are being set up as HealthHubs. HealthHubs are almost like urgent care clinics inside the existing store location, giving folks access to convenient and lower cost after-hours, or just simpler, health visits. On top of this, stores are being set up to ship products that are ordered online, with many also as convenient UPS drop-off locations making each location a mini distribution center. The digital push makes this smaller store, networked distribution increasingly easier.

True, CVS has announced their intention to close some stores, roughly 900 over the next three years. This still leaves 9,000 stores across the Nation - and the savings not spent on physical location rent as well as some staffing - to improve and add more services as they rework other store offerings. They have stated numerous times that they are optimizing their "retail portfolio to serve as community health destinations." They are doing this by building, or enhancing, more stores into HealthHub locations. As they expand care center services, they are working with technology to continue expanding their reach and expertise by reaching people digitally, and this is where the picture gets even better…

CVS's Digital Strategy
CVS already states they have 35 million digital customers. Most of these are folks who are using the CVS app to order products and prescriptions from CVS. Increasingly I would imagine the app and digital service will become a way to reach doctors for questions and telehealth visits as CVS pushes towards virtual visits. (Aside from offering coupons to keep users more sticky.)

CVS is leveraging their drugstore/PBM's highest prescription drug market (again, a roughly 25% market share) and the national healthcare reach of Aetna to reach more and more consumers with convenient access to health services. On top of this CVS is partnering with Teladoc, providing opportunity and even more reach to consumers who are looking for virtual doctor visits and convenience.

Some Numbers
Previous earnings came out in November of 2021, so we are anxiously looking forward to the next statement on February 9th, 2022. Their prior Q3 announcements showed beat on pretty much all fronts, including an over $3 Billion top-line beat. Non-GAAP EPS of $1.97 beat expectations by $0.18. (GAAP EPS had an EPS of $1.20, a rare miss of $0.20) This all was from a healthy revenue or $73.79 Billion, a roughly 10% Year over Year gain.

FCF for the quarter was $4.9 Billion, up from $1.3 Billion in the same quarter of 2020. Adjusted earnings for the full year, which they will announce soon, were expected to be roughly 6% growth. This increasing income allowed CVS to pay down $6.5 Billion in long-term debt year-to-date and get roughly $21 Billion off the books from the transformational Aetna merger from 2018. Management had previously estimated to hit a target leverage ratio of about 3x at the end of 2022. They hit that number roughly a year early.

Comparisons in and Outside of the Industry
CVS is really a company looking to be unique by offering a host of products that nobody else offers. While they are unlikely to be the only company offering these services, they are moving to transform the industry by leveraging their strengths in a logical manner. They have the opportunity to truly differentiate themselves from others, depending on what they do from here. Either way, they surprised many market enthusiasts and analyst "experts" by doing what they said they would when they purchased Aetna years ago.

Walgreens (WBA) is really the closest similar business, though they do not have the large healthcare offerings. Walgreens seems to be pivoting to a similar mold as CVS and has some good prospects going forward, possibly also being undervalued, but that is a different discussion altogether. In the comparisons below, I included Amazon - which is looking to compete - as well as Walmart and a few others that have similar income or some overlapping business.

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Ratios and Comparison List, Self-Created using current Seeking Alpha data

This stock list shows that even with the gains over the last year or so, CVS still does not get all the market credit it deserves. Target (NYSE:TGT) has a somewhat similar market-cap but roughly one-third the revenue or CVS. UnitedHealth is in a similar field but is valued over 40% higher even with a lower dividend yield. Numerous other comparisons are rather easy to see.

"Strategic Cash Investments"

Ok, admittedly this section is where I get into the weeds a bit. CVS has straightforward plans and can improve results with simple execution of their strategy, but a few things were mentioned many times that have me wondering. In the last presentation at the J.P. Morgan Healthcare Conference, CVS stated their plan for long-term capital was both very simple to understand and attractive to long-term investors. Goals include making sure they have "differentiated care delivery assets" including virtual assets and a "deep health care experience". They also look to scale assets and to use a connected and digital model including "virtual and in-home care".

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CVS later states that they want to:

* Invest 25% to 35% into the business to grow and capture more opportunities.

* Allow for 45% to 55% for "value-added" or "capability-focused M&A" opportunities.

* Provide an attractive dividend with roughly 20%, growing over time with EPS gains.

What has me so interested is their constant mentions of the words 'virtual' and 'digital-first' in all the most recent materials.

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J.P. Morgan Health Conference Slide 7 for CVS, Author Highlights point 3 and 4

It seems to simply show that CVS is going to continue to use Teladoc's suite of services to continue to grow and diversify. It might be rampant speculation, though something I would highly consider if I was in their position to continue to leverage the relationship with Teladoc to offer more virtual care. (This would allow CVS to reduce the store count, the 900 expected reduction over the next three years, without really losing the consumers in those regions and still offering patient services.)

If I am allowed to be even more bold, I would assert that CVS could even consider purchasing Teladoc for its assets and growth. (Teladoc purchased/merged with Livongo in October of 2020 in an all-stock deal. Admittedly, the deal was priced at a combined company value of $18.5 Billion. Current valuation shows the Teladoc merger has a lot of naysayers as it has a current market cap of $12 Billion right as it nears profitability. This could be worth it at the right price, likely only costing CVS one year's FCF.)

Another interesting thought is that the global telehealth market is forecasted to grow anywhere from $300 Billion to $700 Billion by 2028. (That is outstanding growth opportunity even on the smaller side!) CVS Health and Aetna, using Teladoc software, could have some early signs of software acceptance. The access to Teladoc software could show CVS some of the income that Teladoc is expecting, but also might make a bit easier as they share access. Admittedly, the roughly 25-30% compound growth TDOC expects would assist CVS in beating the numbers if it were under the CVS Health umbrella. (But I digress...)

Wrapping Things Up
Speculation aside, CVS - the once stodgy corner drugstore - is finally starting to catch the attention of the market. It has transformed itself into a national player on the healthcare stage and is setting itself up for more growth, while still being a great value. Of course, current market dynamics are likely to be very rocky as inflation and Fed bonds, rates, etc. take center stage.

If I had no CVS stock today, I would consider this a moderate Buy. CVS is undervalued when compared to most of the market. (S&P current ratio shows a PE of 24 while CVS gets a PE ratio of only 12.) Since I currently own CVS and have enjoyed the nice gains over the last year or so, I am in no hurry to add shares at this point. However, I will heavily consider it if it falls in a larger market correction and I would recommend others consider the same.

Disclosure: I/we have a beneficial long position in the shares of CVS, TDOC 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.