CVS: A Moderate Buy

Summary

The CVS stock has been a moderate buy in recent times because of its stability in the last 15 years. Apart from its increasing revenue, CVS has also increased its investment in tech-based services — providing customers with more efficient pharmaceutical and insurance services. CVS also acquired insurance giant Aetna in 2018, giving it access to multiple growing industries.

Main Points

• The CVS Stock is heavily undervalued at a base case undervaluation of 55% (Current Price: $55.81, Intrinsic Value: $122.78).
• It has one of the lowest P/E ratios out of all companies in the Healthcare industry at around 10:1.
• 3 billion dollar investment into technology upgrades in 2022
• However, Operating Margin is at an all-time low of 3.8%.
• 7.5% year-by-year increase in revenue.

Investment Thesis

CVS is currently a neutral investment opportunity because of the strengths and weaknesses it has in terms of revenue stability, profit margins, debt, market position, and strategy.

Introduction

CVS is primarily a healthcare company offering products such as prescription medications, wellness products, personal care, and beauty products. Recently, in 2018, CVS has forrayed into the insurance industry by acquiring Aetna, one of the largest health insurance companies operating in the US. Apart from this, CVS also acquired Oak Street Health, a large primary care company focusing on delivering healthcare to underserved communities who have access to Medicare.

Analysis

In terms of revenue stability, CVS’s revenue has had a neutral increase of 7.5% year over year. Bullish investments usually have an increase of 20% year over year, and vice versa for Bearish investments, but the slight increase for CVS indicates a slight leaning toward being a bullish investment. The reason for its stable rise in income comes from diversifying into different avenues such as its HealthHUB expansions. However, the profit margins indicate that CVS is struggling to break out of the heavy operating costs it faces in the healthcare industry, which is highly regulated. Companies will usually want their operating margins to be more than 7% to be considered as a bullish investment, but pharmaceutical companies like CVS tend to have higher operating margins at about 20 to 30 percent. This shows that CVS’s operating margin contributes to why CVS is a neutral investment opportunity, as their operating margin is merely 3.8%. Additionally, CVS’s total debt is at $59 billion, which limits its financial flexibility in terms of leverage during business decisions. This would contribute negatively to the total position of neutrality towards the stock. However, both their market position and their recent strategic initiatives point towards a net neutral rating. In terms of market position, CVS has a stronghold over the healthcare industry, holding 24.5% of market shares in the US pharmaceutical sector. Adding on, their strategic initiatives have also propelled their control over the healthcare sector with high-profile acquisitions of companies like Aetna and Oak Street Health, propelling them towards sectors like insurance and primary care, respectively. Apart from this, the forward P/E ratio for CVS is 9.8x, compared to the industry average of 14x. The lower ratio indicates that CVS is highly undervalued (55%) and has a huge scope for improvement in the future; however, the lower ratio also indicates integration challenges through its newer acquisitions. Overall, the position is neutral, because there are evenly matched bullish and bearish features of this stock.

Financials

There are several strengths and weaknesses in investing in CVS. Assets, liabilities, and equity will be analyzed for the balance sheet. In terms of assets, CVS had total assets at about $238 billion in Q2 2024; 10 billion dollars being in liquidated form. However, the company also has a high amount of liabilities at around $171 billion with a total amount of debt being $59 billion. The company’s debt-to-equity ratio is about 0.88, indicating that CVS is low risk in terms of being an investment and that they are in good financial health. In terms of cash flow, CVS has an FCF value of 5.3 billion dollars and an FCF margin of 1% which is much lower than the average for efficient companies able to limit CapEx and OpEx. Companies with efficient free cashflow values and margins tend to grow much faster due to the remaining cash they have by limiting CapEx and OpEx. Nevertheless, CVS generated about $16 billion in operating cash flow, which indicates that they have strong cash generation capabilities, which in turn manage debt, and funds growth and support dividends and buybacks. Additionally, CVS has also invested in growth in the past year by acquiring Oak Street Health; the net amount used for investing in 2023 was around $10 billion. Additionally, in terms of its Income Statement, CVS had an earnings-per-share (EPS) of about $6.1, which shows moderate growth from 2022 — indicating an improvement in share heath. Contrastingly, CVS’s share price is around $70, and has been relatively volatile in recent times due to difficulties in growth and an increase in competition. Overall, strengths like CVS’s assets, D/E ratio, cashflow amount, investments and EPS value coupled with weaknesses like high levels of debt, a low FCF margin, and a volatile stock price.

Valuation

Valuation done through Discounted Cashflow Analysis (DCF)

According to Alpha Spread, CVS’s DCF value lies at $124.33 USD in the base case scenario. This figure is procured through a forecast period of 5 years, a discount rate of 7.78% (a figure made through careful analysis of the CVS stock in the past 5 years, and a terminal growth of 0%. Using a 7.5% growth rate every year for 6 years, the revenue each year goes as such: 379 B, 399 B, 425 B, 450 B, 467 B, and lastly 477 B. Additionally, using a 2% growth rate every year for 5 years, the revenue each year goes as such: 2.4%, 2.62%, 2.8%, 2.86%, 2.92% and lastly 2.98%. In terms of net CapEx, each year goes as such: 40 M, -195 M, -459 M, -754 M, -1061 M, and lastly -1365 M. Putting these together, the revenue goes from 379.2B to 476.5B, the net income goes from 9.1B to 14.2B and FCFE goes from 9.2B to 12.8B. Synthesizing these numbers, CVS’s DCF value comes out to $124.33 USD, a 55% undervaluation from $55.81. This indicates that CVS’s stock may be viewed as an investment opportunity by investors as they expect the stock price to increase to represent the DCF value. If there are more investors, then CVS’s stock price will increase, again showing why the DCF model views CVS as a viable investment opportunity.

Risks

Some of the main risks for CVS include competitive risks, debt levels, and regulatory risks. In terms of competitive risks, competition like Amazon, Walgreens and other healthcare providers expanding toward technology could pressure CVS’s margins and market share. Additionally, CVS’s debt could increase debt servicing costs, decrease profitability, and increase budget rigidity. This debt has mainly been built up by high-value acquisitions by Aetna and Oak Street Health. Lastly, changes to healthcare laws, drug pricing, and insurance systems could help/hurt CVS significantly.

Catalysts

Some catalysts for CVS could include their recent acquisitions as well as their huge investments in technology. Firstly, large-scale acquisitions such as Aetna and Oak Street Health helped CVS introduce itself into primary care as well as insurance, both hugely profitable industries in the health sector. Furthermore, CVS invested a 3 billion dollar investment into technology upgrades in 2022 and specifically set up their data analytics unit with the use of Artificial Intelligence for better preference analysis. Both of these aspects could affect the stock price throughout the next couple of years.

Conclusion

In conclusion, CVS is currently a moderate investment opportunity because of its strengths and weaknesses in terms of financials, catalysts, risks, and valuations. Investors might be encouraged to dive into investing in CVS because of its heavy undervaluation by DCF, but all other aspects must also be taken into consideration. Based on all the data presented in the article, CVS is seen as a neutral stock to invest in.