CVS Caremark - Little Appeal Despite A Nice Strategic Addition

| About: CVS Health (CVS)

Investors in CVS Caremark (NYSE:CVS) applaud the company's move to acquire Coram, boosting the long-term strategic appeal of the company. The relatively modest deal makes strategic sense, and seems to be justifiable on a price basis.

Yet it is the strong momentum in 2013 which has made shares a bit too expensive to my taste to initiate a new position. If I held any position, I would take some profits at current levels.

The Deal

CVS Caremark announced that it has entered into a definitive agreement to acquire Coram, the specialty infusion and enteral nutrition business of Apria Healthcare Group. CVS will pay roughly $2.1 billion for the business.

Coram is one of the largest providers of comprehensive infusion services, to over 20,000 patients per month. The company cares mostly for its patients through home infusion, while it also has a network of 85 locations throughout the US.

The acquisition complements CVS's strategy to invest in its core business to further drive growth.

Jon Roberts which is President of the Pharmacy Services business commented on the rationale behind the deal, "Bringing together CVS Caremark's unique range of specialty pharmacy services with Coram's infusion capabilities will expand our competitive offerings in the specialty arena. Our comprehensive services will enable us to streamline care management for patients as well as their physicians, leading to better health outcomes while avoiding unnecessary costs."

The deal is expected to add $1.4 billion in revenues in the first twelve months following closure of the deal.

Even when factoring in one-time charges as well integration costs, the deal will have an immaterial impact on the results for 2014. The deal is expected to be accretive to 2015's earnings by $0.03 to $0.05 per share.

The deal is subject to normal closing conditions including regulatory approval and is expected to close in the first quarter of 2014.

Third Quarter Results

About three weeks ago, CVS released its third quarter results. Revenues rose by 5.8% to $32.0 billion, driven by the company's Pharmacy Services business.

Income from continuing operations rose by 24.6% to $1.3 billion in the meantime. Full year GAAP earnings from continuing operations are seen between $3.73 and $3.76 per share.


CVS ended its third quarter with $1.6 billion in cash, equivalents and short-term investments. Total debt stands at $10.2 billion, for a net debt position of $8.6 billion.

Revenues for the first nine months of the year came in at $94.0 billion, up by 2.4% on the year before. Income from continuing operations rose by 21.2% to $3.3 billion in the meantime.

Annual revenues could come in around $126 billion as earnings from continuing operations are seen around $4.6 billion.

Trading at $67 per share, the market values CVS Caremark at $80 billion. This values equity in the firm at 0.6 times annual revenues and 17-18 times annual earnings.

CVS currently pays a quarterly dividend of $0.225 per share, for an annual dividend yield of 1.3%.

Some Historical Perspective

Long-term holders in CVS have seen excellent returns. Over the past decade shares have long traded in a $20-$40 trading range. Following the economic recovery and introduction of "Obamacare" shares have seen even more upside, currently trading at all time highs at $67 per share. Shares have already risen nearly 40% so far this year.

Between 2009 and 2013, CVS is on track to report nearly 30% revenue growth on a cumulative basis, to expected revenues of $126 billion. Earnings are set to increase by roughly a quarter to $4.6 billion. The company retired roughly 15% of its shares outstanding over this time period.

Investment Thesis

Investors are cautiously optimistic about the deal, although the $1.4 billion in revenues adds merely over 1% in annual revenues to CVS. At a first glance, the $2.1 billion price tag looks expensive at a revenue multiple of 1.5 times, compared to CVS' own valuation at 0.5 times annual revenues.

Yet 3-5 cent per share accretion to 2015's earnings implies earnings power of $50 million per annum in additional earnings. Assuming financing rates of 4% for the $2 billion in additional debt, and the deal adds roughly $130 million in earnings on a stand-alone basis. This makes these multiples reasonably attractive in terms of earnings, while the unit is undoubtedly showing fast growth.

With the deal CVS will enter the home infusion terrain which is growing really fast in the aim to control healthcare costs. Patients can use needles or catheters to self-administered medicines, nutrition or antibiotics, saving the system on very expensive trips to the hospital.

So far investors in CVS have a great year fueled by operational growth and strong shareholder payouts. While the dividend yield is modest at 1.3% per annum, the company is on track to repurchase roughly $4 billion worth of its shares, at a pace of 5% per annum at current levels.

Back in December of last year, I last took a look at CVS's prospects. Shares were trading around $47 per share at the time and have risen some 50% ever since. The 38% hike in its quarterly dividend at the time, and $4 billion targeted repurchases for this year have been a major diver for the shares.

I concluded at the time that I liked the prospects for the firm given the implementation of the Affordable Care Act, and favorable demographic shifts.

While the strategic deal of CVS is appealing in the long term, given the urgency to control healthcare costs, the valuation has increased too much over the past year on the back of the strong momentum in 2013. At these levels it certainly would not hurt to take some profits, and I think investors are too late to pick up some shares given the unfavorable risk-reward ratio at current levels.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.