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Wednesday, 06/07/2023 12:03:13 PM

Wednesday, June 07, 2023 12:03:13 PM

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Is It Time To Bet On CVS?
By: Barchart | June 7, 2023

The June/July issue of Fortune is out. It is dedicated to its Fortune 500 rankings. One CEO who appears prominently in the magazine is CVS (CVS) CEO, Karen Lynch.

Not only does Lynch appear in an article lamenting that despite the number of female and Black CEOs in the Fortune 500, it's still an abysmal record. I couldn’t agree more.

However, that’s not why I’ve brought up Lynch’s name.

The reason I’m talking about Lynch is that she appears in a second article in Fortune’s latest issue discussing Big Healthcare and whether it will be able to fix what ails America’s healthcare system.

CVS stock is down 24% year-to-date and up just 7% over the past five years. While the article paints a positive picture of CVS’s contribution to fixing healthcare in America, the appearance in Fortune could be a curse rather than a blessing.

My big question is whether it’s time to bet on CVS.

The Upside For CVS

First of all, for all those like me who didn’t know this juicy factoid: Fortune points out that the company began life as the Consumer Value Store, hence the CVS acronym. I’m a business history freak, so that’s one to file away, but I digress.

Since Lynch became CEO in 2021, she’s made two mid-sized acquisitions: In September 2022; the company announced that it would acquire Signify Health for $8 billion. It completed its acquisition of the home healthcare provider in late March.

“This transaction advances our value-based care strategy by enhancing our presence in the home,” Lynch stated in CVS’s press release announcing the acquisition’s completion. “Our expanded capabilities will bring us closer to the consumer as we continue to redefine how people access and experience care that is more affordable, convenient and connected."
In February, CVS announced a second multi-billion-dollar acquisition, agreeing to pay $10.6 billion for Oak Street Health. This primary care provider operates storefront clinics in lower-income neighborhoods in 21 states.

“Combining Oak Street Health's platform with CVS Health's unmatched reach will create the premier value-based primary care solution,” Lynch said in February, announcing the deal. “Enhancing our value-based offerings is core to our strategy as we continue to redefine how people access and experience care that is more affordable, convenient and connected.”

The company’s transformation from a pharmacy chain to a pharmacy benefit manager to a primary care provider and, ultimately, to representing your entire healthcare ecosystem started years ago but is now accelerating under Lynch.

“While recognizing that we have shareholders, and a lot of different stakeholders, my personal passion is, ‘How do we improve the health care system?’?” Lynch told Fortune. “We have the opportunity to really drive engagement, simplicity, effectiveness—and to drive patients to the right care at the right time, in the right places.”

While there is no doubt that the stakes are high, if CVS can walk the fine line between altruistically helping patients and profiting handsomely from doing so, five to 10 years from now, those holding over the entire period will be greatly rewarded for their patience and loyalty in the plan.

That said, its stock has performed poorly in recent years precisely because investors doubt its long-term strategy.

The Big Downside to Its Vision

As Fortune points out, CVS is one of several large healthcare companies looking to transform the American healthcare system through value-based care, a panacea that might not come to fruition.

“In conversations with a couple dozen stakeholders, including three former CMS administrators, about Big Health Care’s fitness for the value-based care role, most opinions landed between skeptical and wait-and-see. Will care improve? Maybe, through better coordination. Will it lower costs? Unlikely. Is investment in primary care, whatever the source, a good thing? You bet,” Fortune contributors Maria Aspan and Erika Fry wrote.

So, if doctors, other health practitioners, and patients fail to buy into the value-based model pushed by companies like CVS, the expensive acquisitions Lynch and the company’s previous CEOs have made -- $130 billion since 2006 -- will have all been for nothing.

Let’s put it this way.

Before its acquisition spree began, CVS had $1.6 billion in long-term debt in 2005. That was 10.4% of its total assets. At the end of March, its long-term debt was $56.5 billion, or 23.6% of its total assets, more than double what it was less than 20 years ago.

Sure, its operating profits have grown from $2.0 billion in 2005 to $7.7 billion in 2022, a compound annual growth rate (CAGR) of 8.3%. However, the CAGR of its debt was nearly 23% over the same period.

With higher interest rates, this becomes a far more significant issue should the business model fail to gain the traction necessary to pay for all of this debt incurred.

Is It Time To Bet on CVS?

CVS has a trailing 12-month free cash flow of $17.4 billion. Based on an enterprise value of $145.4 billion, it has a free cash flow yield of 12%. I consider anything over 8% to be in value territory.

So, my answer would be yes, but only if you’re a patient investor. Lynch’s plan could take several years to play out.

I guess we’ll find out.

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