CVS: A Core, Multi Decade Dividend Holding

| About: CVS Health (CVS)

Summary

CVS has proved to be a consistent, solid performer over an extended period of time, delivering superior investor returns.

While providing modest yield today, CVS should be a solid dividend payer over the coming decades.

I have high conviction in the long-term success of the company's business model, and I'm accumulating the shares regularly on a quarterly basis.

I'm creating a dividend portfolio via my Dividend Accumulation Motif comprised of 30 dividend stars across all sectors to regularly accumulate for the next 30 years. I've tried to identify wide-moat, high-return businesses that I'm comfortable will be around and will be thriving over that period of time. CVS (NYSE:CVS) is the only healthcare retailer that made it into my list of 30 stars.

A high-quality, long-term performer

CVS has been in business since 1892. The company is one of the largest pharmaceutical benefits managers and retail pharmacy operators in the US. The operating performance of the company has been quite strong over a consistently long period of time. CVS has increased revenues from $37B in 2005 to over $140B in 2014, representing an annualized growth of close to 16%. During this same period, net income has increased from $1.2B to almost $4.6B, an annualized growth rate of almost 18%. CVS has a market capitalization of $103B and currently trades at a forward P/E of 14 and offers a dividend yield of close to 1.25%.

The business has rewarded long-term shareholders well, and its dominant performance is no doubt a reflection of quality. Investors who invested $10,000 in CVS in 1984 would have a stake that was in excess of $370,000 today and that has returned 12.4% annually.

Favorable long-term trends

CVS was attractive to me because it provides a thematic play with increasing healthcare consumption in the US. The consumption of specialty prescription drugs is a development that is only going to accelerate, with an aging population and with efforts to include a greater proportion of the US population under some system of health insurance coverage. The higher consumption of these specialty drugs and the increasing expense of plan administration should see an acceleration of business to pharmaceutical benefits managers, with the largest managers the best placed to win the majority of the business. Specialty drugs to treat complex conditions such as Multiple Sclerosis, Hepatitis C and cancer can be very expensive. A one-course treatment for a Hep C drug can cost almost $100,000. In this environment, with more complex, expensive drugs, pharmacy benefits managers will play a significant role in helping keep pharmacy costs in check for payers. The proliferation of generic drugs creates opportunities for PBMs such as CVS to achieve better margins over time in the satisfaction of patient claims.

Scale is key to CVS' dominance

CVS has significant scale in drug sourcing that gives the company a significant advantage in supplier negotiation with drug companies. This sourcing power stems from the company's extensive retail pharmaceutical presence which CVS has further extended into a solid presence as a pharmaceutical benefits manager ("PBM"). The volume of sourcing that CVS does enables preferential terms from drug manufacturers that other players with less scale can't touch. In turn, this favorable drug pricing makes CVS a very attractive pharmaceutical benefits manager for companies, helping them to achieve good outcomes in claims administration. The large volume of claims processed as a PBM further solidifies CVS' sourcing advantage and moat.

Omnicare provides complementary capabilities

CVS' acquisition of Omnicare allows the business to touch adjacent aspects of the pharmacy value chain in which it's not a strong player today. Omnicare offers a range of complementary capabilities including supply chain solutions and support services to physicians, nurses and patients, which should further increase the stickiness of the relationship with key stakeholders in the drug dispensation process to CVS.

Strong total returns should give way to solid dividend income

CVS has been a solid total return performer. Of this there is little doubt. Over the last 10 years, CVS has comfortably trounced the S&P 500 in terms of total return. The business delivered a total return of 13.85% annually over the last 10 years compared to an annual return of 6.35% for the S&P 500.

Despite being a dominant performer, CVS doesn't make its way onto the radar of most dividend investors. That's understandable because the current dividend yield for CVS is just 1.5%. However this understates some things that have been happening recently with CVS' commitment to paying a dividend.

CVS has increased the dividend per share by almost 9 times over the last decade. The company's dividend payout ratio also has shown steady progressive growth, and now stands at almost 30%, having increased from just 10% in 2005. A 30% payout ratio is still relatively modest which means that CVS' dividend payout is only going to be further increased over time.

Best of all, CVS' dividend growth has been and will continue to be solidly driven by organic growth. Earnings per share tripled over the last decade, while operating cash flows are up almost 5 times since 2005. CVS' earnings per share are forecast to increase by 14% annually over the next five years, which suggests that CVS investors should be able to enjoy similar growth in the dividend, even in the absence of payout ratio increases.

Valuation

CVS currently trades at a P/E ratio of 21 and a forward P/E ratio of just over 14. CVS is trading slightly above its average multiples over the last five years such as price to cash flow and price to sales. However significantly for me the company is currently at a PEG ratio of 0.8, which suggests that it may be good value compared to future expected growth. Morningstar has CVS stock at 3 stars currently.

I'm very bullish on CVS' long term prospects. This is a business that I'm happy to continue to accumulate.

Disclosure: I am/we are 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.