CVS Health (CVS) was not immune from the market declines inflicted by the COVID-19 downturn. Despite being in the traditional defensive healthcare space and confined to domestic operations, the stock could not break out and participate in the broader raging bull market post-COVID-19 lows. Despite a string of better than expected earnings, generating large amounts of free cash flow, paying down debt, and returning value to shareholders, the stock has up until recently been bogged down. The Aetna acquisition has been fully integrated while demonstrating robust earnings despite the COVID-19 backdrop. The company is finally getting some long-awaited respect on Wall Street, especially in conjunction with the positive vaccine developments. CVS has seen its stock rapidly appreciate as a function of strong company fundamentals and as a COVID-19 value rotation play. Despite the current stock appreciation, CVS still presents a compelling investment opportunity as the CVS-Aetna combination will drive shareholder value for years to come.
Perpetual Stock Slump
CVS has been in a perpetual stock slump with or without COVID-19 in the backdrop. CVS has been beaten down for years, plummeting by over 50% ($113 to $52) from its multi-year highs. Due to its recent breakout with strong company fundamentals and part of the COVID-19 value rotation, the stock has elevated to above $71. The company has posted a string of positive earnings with plenty of runway left in its growth from its Aetna acquisition. This was a bold and hefty price tag to pay yet necessary to compete in the increasingly competitive healthcare space, changing marketplace conditions, and political backdrop with drug pricing pressures. CVS made a defensive yet necessary acquisition to enable the company to go back on the offensive. The combination of CVS and Aetna was a bold and successful move after initial skepticism by investors. The CVS-Aetna combination will boost long-term growth prospects, restore growth, and fend off potential competition. This combination creates the first through-in-through healthcare company, combining CVS's pharmacies and PBM platform with Aetna's insurance business. The new CVS combines its existing pharmacy benefits manager (PBM) and retail pharmacies with the second-largest diversified healthcare company.
CVS Q3 Earnings
CVS reported a better than expected 3.5% increase in Q3 revenue as its Aetna acquisition comes into the fold. The company also raised its 2020 earnings guidance as its vision of becoming a through-in-through healthcare company via offering insurance to COVID-19 testing. CVS has been transforming itself into a singular healthcare destination as the competitive landscape threatens its moat. The company is redesigning hundreds of its stores with medical services and products, such as blood testing and sleep apnea machines. By the end of the year, CVS will have roughly 600 healthHUBs, while it currently has 450 in 30 states. It plans on adding behavioral health services at these stores as well (Figures 1 and 2).
CEO Merlo said the addition of Covid-19 testing is "a very tangible proof point of our strategy coming to life in a very meaningful way."
"If we told you a year ago that to date 6 million people would have gone to their local CVS pharmacy for a diagnostic test related to some virus, I would probably get an eyeball roll," he said. "The reality is that's happened, and it really speaks to the strategy that we've talked about in terms of meeting people where they are."
Revenue rose 3.5% to $67.06 billion, from $64.81 billion a year prior. It also beat the $66.66 billion expected by analysts. At the company's drugstores, sales rose in both the pharmacy and the front of the store as customers filled more prescriptions, got Covid-19 tests, and purchased over-the-counter items.
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Prescriptions filled increased 4.6% on a 30-day equivalent basis in the quarter compared with the prior year. Front store revenues increased by 2.7% in the quarter compared with the prior year. CVS raised its full-year guidance for earnings per share to between $5.60 to $5.70 from $5.16 to $5.29 and its full-year 2020 adjusted earnings per share guidance range to $7.35 to $7.45 from $7.14 to $7.27. It said its cash flow for the full year would range from $12.75 billion to $13.25 billion, higher than its previous outlook of between $11 billion to $11.5 billion.
CVS has expanded COVID-19 testing, administered flu shots, and prepared for the coronavirus vaccine rollout during the pandemic. It has more than 4,000 drive-thru test sites at its pharmacies and has administered more than 6 million tests. The company said it plans to have nearly 1,000 sites for rapid testing by the end of the year. CVS and Walgreens announced a deal with the government to administer coronavirus vaccines to the elderly and staff in long-term care facilities when they become available.
Figure 1 – Q3 2020 earnings highlights
Figure 2 – CVS paying down debt and generating strong cash flow
CVS-Aetna Synergies
With the enterprise synergies via the Aetna combination, the newly formed CVS will continue to unlock value and growth over the long-term. This value creation will come through medical cost savings, membership expansion, customer retention, expanded customer value, and partnerships. This can already be seen from its recent string of positive quarterly reports. CVS's transformation is still in the early innings with plenty of runway for market opportunities and growth.
Summary
CVS Health (CVS) has been beaten down for years, plummeting by ~50% from its multi-year highs, and has been a value trap along the way. CVS has been pressured from all directions, specifically with drug pricing pressures eroding margins and limiting margin expansion over time. A secular decline in brick and mortar retail has hindered foot traffic and same-store sales growth. To boost long-term growth prospects, restore growth, and fend off potential competition, CVS acquired Aetna. This pharmaceutical supply chain heavyweight is surviving and competing and reviving its dominance in the marketplace now that its combination with Aetna has been fully integrated. CVS generates large amounts of free cash flow, paying down debt, and returning value to shareholders with continuing to pay out dividends. I feel CVS is early in its transformation and presents value coupled with a solid growth profile for the long-term investor. Unfortunately, CVS has been a value trap throughout this transformation; however, I have always felt that it was a matter of time before the stock appreciated. We are finally witnessing the stock breakout. CVS has seen its stock rapidly appreciate as a function of strong company fundamentals and as a COVID-19 value rotation play. Despite the current stock appreciation, CVS still presents a compelling investment opportunity as the CVS-Aetna combination will drive shareholder value for years to come.
Noah Kiedrowski
INO.com Contributor
Disclosure: The author holds shares in AAL, AAPL, AMC, AMZN, AXP, DIA, GOOGL, JPM, KSS, MSFT, QQQ, SPY and USO. He may engage in options trading in any of the underlying securities. The author has no business relationship with any companies mentioned in this article. He is not a professional financial advisor or tax professional. This article reflects his own opinions. This article is not intended to be a recommendation to buy or sell any stock or ETF mentioned. Kiedrowski is an individual investor who analyzes investment strategies and disseminates analyses. Kiedrowski encourages all investors to conduct their own research and due diligence prior to investing. Please feel free to comment and provide feedback, the author values all responses. The author is the founder of www.stockoptionsdad.com where options are a bet on where stocks won’t go, not where they will. Where high probability options trading for consistent income and risk mitigation thrives in both bull and bear markets. For more engaging, short duration options based content, visit stockoptionsdad’s YouTube channel.
