Investors in CVS Caremark (NYSE:CVS) reacted very positively to the presentation which the company gave for 2014 and the years beyond. Shares traded at fresh all-time highs as investors applauded the guided growth, while the company continues to return cash in large quantities to its shareholders.
Despite this attractive outlook, I remain on the sidelines as the valuation multiple has increased quite a bit in recent years on the back of strong momentum in its shares.
Long-Term Strategy Update
Last week, CVS updated the market about its long-term growth strategy, accompanied by the 2014 guidance.
Adjusted earnings for 2014 are seen between $4.36 and $4.50 per share, up 10 to 14% on the year before. Earnings on a GAAP basis are seen between $4.09 and $4.23 per share.
Revenues are seen up 4% to 5.25%, resulting in expected annual revenues of around $132 billion. Growth is partially supported by same store sales growth of 0.75 to 2%.
Larry Merlo CEO of CVS commented on the future developments, "CVS Caremark has an in-depth understanding of the changing health care landscape, including the challenges and opportunities that lie ahead, These changes in the environment are creating opportunities for the company, and our unique combination of ability and agility positions us to capitalize on these opportunities - however they take shape."
The company sees very strong free cash flow generation between $5.1 and $5.4 billion, allowing CVS to repurchase $4 billion worth of its own shares next year.
"Retailization Of Healthcare"
CEO Merlo continues to see the "retailization" of health care, which is the rise of consumerism driven the by the increasing number of consumer-driven health plans.
CVS drives innovation to meet the changing and higher needs of customers, focusing on winning market share. The unique business model which focuses on better access, lower costs and better healthcare outcomes is providing a great value proposition to end customers.
As Merlo and the other executives are upbeat about the future, they and the board decided to increase the pay to shareholders. The company boosted its quarterly dividend by 22% to $0.275 per share. On top of that, the board approved a new $6 billion share repurchase program, of which it aims to complete $4 billion in purchases next year.
Back in November, CVS released its third quarter results. The company ended the quarter with $1.61 billion in cash, equivalents and short term investments. Total debt stands at $13.33 billion, for a net debt position of $11.72 billion.
Revenues for the first nine months of the year came in at $93.98 billion which is up 2.4% on the year before. Earnings from continuing operations came in at $3.34 billion, up 21.2% on the year before.
At this pace, full year revenues are seen around $126 billion as earnings from continuing operates could come in around $4.8 billion. Trading around $71 per share, the market values CVS at $85.5 billion. This values equity of the firm at 0.7 times annual revenues and 17-18 times annual earnings. Previously, CVS announced that it sees full year earnings approaching $4 per share.
The proposed quarterly dividend of $0.275 per share provides investors with an annual dividend yield of 1.5%.
Some Historical Perspective
Long-term investors in CVS have seen great returns. Between 2004 and 2011, shares have traded in a $20-$40 price range. Since 2012, shares have risen to fresh all-time highs of $71 per share at current levels.
The recent jump came on top of the economic recovery and the much anticipated introduction of "Obamacare", marking year to date returns of 47% which is very strong for such a large-cap.
Between the year of 2009 and 2013, CVS has grown its revenues by some 30%, with revenues seen just north of $125 billion this year. Earnings are set to rise at almost similar percentages to $4.8 billion. The company has boosted earnings per share growth, by retiring another 15% of its shares outstanding over this time period.
Returns of CVS are driven by high payouts to shareholders. The expected $4 billion repurchase program targeted next year will imply a 4.7% return to shareholders. On top of that, investors stand to receive a 1.5% explicit return in terms of dividends, for combined returns of 6.2% per annum.
Back in November, I last took a look at the prospects for CVS after the company acquired Coram, which is a specialty infusion and enteral nutrition business. CVS paid $2.1 billion for the business, which provides infusion services to 20,000 patients per month, which is expected to add $1.4 billion in annual revenues. The company has 85 locations throughout the US.
The price tag seemed expensive at the time, at 1.5 times annual revenues, which compares to CVS' own valuation at 0.7 times annual revenues. The modest accretion to future earnings, makes the deal much more attractive, gaining terrain in a fast growing area of the healthcare industry.
The strong fundamental tailwinds, strong execution and repurchases continue to drive returns, and CVS sees continued solid growth for the next 5 years. Shareholders have already anticipated these fundamental improvements, resulting in a valuation multiple increase amidst dividend hikes and high repurchases.
After the very solid momentum, despite the strong guidance, I believe shareholders are a bit late to jump on the bandwagon at 14 times earnings for next year. At these levels, I don't believe the risk-reward ratio is too compelling to chase shares at these levels.
I remain on the sidelines, but applaud management with a great job being done over the past years, and anticipated in the coming years.