The share price of CVS Caremark (NYSE:CVS) has risen by 14.8% over the past 12 months. At $52.90, the stock is trading near its 52-week high of $52.93 achieved just recently and offers a 1.7% dividend yield. Despite the recent price appreciation, I believe the stock is still a buy based on the following 5 compelling reasons:
1. From a relative valuation perspective, CVS shares are still priced attractively based on its strong financials relative to its peers (see chart below). Consensus estimates on average predict the firm's revenue, EBITDA, and EPS to grow at 2-year CAGRs of 2.8%, 7.2%, and 16.8%, respectively. The figures are fairly in line with the averages of 2.7%, 12.6%, and 12.8%, respectively, for a group consisting of CVS' primary industry peers. Similarly, CVS' long-term earnings growth rate is forecasted to be 12.8%, only slightly above the peer average at 12.4%. On the profit side, CVS demonstrates a superior performance as the company's various profitability margins are considerably above par. However, the firm's capital return metrics including ROE and ROIC are below the averages, though they remain at a healthy level on an absolute basis. CVS carries a relatively lower level of debt as reflected by its below-average leverage ratios. In terms of liquidity, CVS has a higher free cash flow margin and its interest coverage ratio is in line with the group. Both the company's current and quick ratios are above par, reflecting a healthy balance sheet condition.
To summarize, given CVS' in-line growth potential, robust profitability, as well as solid liquidity position, I believe the stock's fair value should reasonably command a premium over the peer-average valuation level. Nevertheless, the current price multiples at 7.5x forward EBITDA (next 12 months) and 13.4x forward EPS (next 12 months) are slightly below the same peer-average multiples. After accounting for the EPS growth estimate, CVS' PEG ratio of 1.05x is consistent with the peer average, suggesting that the stock is modestly undervalued on a relative basis (see chart below).
2. The stock's forward P/E multiple is currently trading slightly below its historical level in a year ago (see chart below).
I believe the lower valuation presents a good entry opportunity given that 1) the consensus EBITDA and EPS estimates for 2013 and 2014 have experienced multiple upward revisions over the past 12 months and they both are notably above the levels in 12 months ago (see charts below); 2) sell-side analysts' long-term EPS estimate has been trending steadily at around 12% over the same period (see chart below); and 3) the 1-year target stock price has been raised from $48.30 to $57.34 (see chart below).
3. Further, CVS' forward P/E multiple of 13.4x is 8.6% below the same multiple of the S&P 500 Index, which stands at 14.6x now (see chart below).
Again, this below-market valuation implies a buy signal provided that 1) the market discount averaged at only about 2.6% in the past 12 months; 2) CVS' long-term estimated EPS growth rate at 12.8% is markedly above the average estimate of 8.2% for the S&P 500 companies; 3) CVS has a solid market share in the drug retailing sector and enjoys industry-leading profitability and free cash flow margins; and 4) the stock also offers a 1.7% dividend yield and the company has been aggressively buying back shares.
4. CVS shares also appear to be priced favorably from a historical valuation standpoint. The stock's trailing P/E multiple of 17.5x is currently trading above its 5-year historical average at 15.1x, which is completely supported by the following positive fundamental developments throughout the period (see chart below):
1) CVS has been able to produce a higher return on investments as reflected by the rising ROE, ROA, and ROIC metrics (see chart below);
2) Although EBITDA has been on a decline over the past 5 years, the consensus estimate draws a recovering trajectory over the current and next 2 fiscal years (see chart below); and
3) CVS has also managed to generate a higher free cash flow margin (see chart below).
5. Analysts remain very bullish on the stock. According to Thomson One, of the total 22 stock ratings, there are 5 strong buys and 15 buys. Following the company's upbeat Q4 earnings result in February, John Heinbockel at Guggenheim reiterated his buy rating for the stock with the following comment (sourced from Thomson One, Equity Research):
"We believe CVS is a fairly reliable 10-12% secular grower with very strong free cash flow characteristics, especially now that the Caremark "cash cow" is back performing well. In addition, the fast-growing specialty Rx business provides another upward tilt to valuation."
Bottom line, investors should consider buying CVS shares in the light of the company's healthy financials, solid growth prospects, and the stock's tempting valuation.
All charts are created by the author except for the consensus estimate tables, which are sourced from Capital IQ, and all financial data used in the article and the charts is sourced from Capital IQ unless otherwise specified.
Disclosure: I am long CVS. 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.