One of our guests on the Dividend Health Checkup Podcast mentioned that Warren Buffett uses a 10 year history of data when looking at his companies. In keeping things simplistic, he looks at the first 3 years of that 10-year period vs. the last 3 years of that period. That is easy enough. That gives cycles time to happen. That gives products time to grow. That gives management time to change. All things considered, one should see growth in all the important categories over those two time periods. As I am nowhere close to Buffett in terms of investing,I took a page from his book here.
The company that has been in my sights lately is CVS Health (NYSE:CVS). The stock has dropped pretty aggressively and it is now in the fair value zone. This is going to be a pure look at the data and not at the company. There have been a couple recent articles that cover the company if you need some background.
- Bryan Boulden - CVS: Thanks Mylan
- Atta Khan - CVS: A Long Term Outlook
- Elizabeth Walker - Is CVS A Promising Buy
The data used here comes from It represents the Fiscal Years (December End) 2006 to 2015.
Revenue, Net Income and Margin
Below are six charts that show two cuts of revenue, net income and margin. The charts on the left show the actual numbers. The charts on the right show the year over year change. Finally, I compare two periods of time. The first period is the average of the first three years and the second period is the average of the last 3 years. This allows you to look across the business cycle to see what has changed over a reasonable period of time. As you can see, CVS dominated by doubling revenue over the past 10 years. What is amazing is that growth came at a relatively stable margin. The margin was slightly down, but the 100% growth in revenue pretty much transferred to a 100% growth in net income. When you look at the revenue and net income change charts, you can see a big chunk of the change was from the first years. Things have slowed a bit recently, but a company of that size in its market growing at this speed is respectable.
Free Cash Flow, Dividends and Debt
As a dividend investor, I love the free cash flow section. This is the actual cash the company generates and keeps to pay for things like dividends. As we know, revenue was up 100% in the comparison periods. So what about cash? CVS dominated. That is the only way to say it. Free Cash Flow is up an amazing 400% over the past 10 years. For a dividend investor there really is not anything better. Next I want to answer what did CVS do with all this extra cash? Well, at the same time it was growing so was the dividend. The dividend is up an equally impressive 400% with the FCF payout ratio only going up 15% (not percentage points). The payout ratio is a healthy 25%. I have done a few articles in this format and this is the first I remember seeing that had this much positive news in the FCF section.
We have seen some good news now lets check some bad news - debt. We all hate it, but when used appropriately it can be ok. Debt is up. There is the bad news statement. CVS has a lot of debt; like 5x net income levels of debt. That is bad. When someone has that much debt I am immediately interested in two things: free cash flow and cost of capital. As we just saw, FCF seems to be just fine. The current weighted average cost of capital is 7.8%. That is reasonable. It is actually down from 10.3% back in 2015. So while I do not love it, I would say that CVS has successfully managed a large debt load over time and grown the business. I give it a pass with a watchful eye.
Cash, ROIC and Shares Outstanding
If you were looking at your personal finance situation where would you start? I would start with my bank account. I would like to know how much cash I have. I want to know the same about any company that I am considering investing in shares. CVS has an interesting history with cash. As we saw above, revenue is up 100%, FCF is up 400%, and cash is up 200%. So CVS is growing its cash to offset some of that debt that we saw. It is also giving some of that back to us shareholders in dividends and share buy backs (small, but 5% reduction over the past 10 years).
While it is great that the company is keeping some money, I want to make sure that it is making a wise investment decision on my behalf. In other words, the cash the company invests should be earning a higher rate than I could get elsewhere and also be able to cover the weighted average cost of capital. In this case, the ROIC is up slightly over the time period. It came in right around 11%, which is a respectable number. It is also higher than the cost of capital. For now, I would say that it is good.
CVS Health is an interesting business that the professionals think has room to grow. Using Fast Graphs, I quickly take a look at its current price relative to its historic price. I think a 15 p/e is fair value. We are trading right around that mark. In addition to buying at fair value, in the second chart, I can see that the company has room to grow. S&P reporting analysts think there is room to return 12% annually to shareholders over the next 3 years. In the short term, it looks like there is some 'catch the falling knife' that will happen. In the long term, I like the outlook.
The article asks the question, is CVS Health creating shareholder value? This one is almost a no brainer. Revenue, Net Income, Cash Flow, ROIC and financial outlook are all-positive. Debt is a little high, but the company has a history of maintaining its high level of debt. In the last note section below you will see that two things are working in favor of the shareholder. First, the company has slowly started to pay down the debt. Second, the company has continued its share buybacks. I say they have created shareholder value and the company is setup to continue to deliver shareholder value into the future. I recently have started a position and will add more as long as it stays within its fair value range.
The information above is completed based on the last full fiscal year (Dec 2015). We have obviously had quarterly reports since then. Below I present the same charts as above, but done on a quarter over quarter basis for your individual review.
Quarterly Revenue, Net Income and Margin
Quarterly Free Cash Flow and Dividends
Quarterly Cash, ROIC and Shares Outstanding
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.