Dividend Analysis of CVS Caremark

A reader has requested that we have a look at CVS Caremark Corporation (CVS). Considering that Walgreen (WAG) is a member of our portfolio of superior dividend yielding stocks, let’s see if one of its competitor’s will have the same distinction.

Company Profile:

From Yahoo Finance

CVS Caremark Corporation operates retail drugstores in the United States. The company, through its stores, offers prescription drugs; general merchandise, including over-the-counter drugs, beauty products and cosmetics, seasonal merchandise, greeting cards, and convenience foods; and film and photofinishing services. It also provides diagnostic services and treats minor health conditions. The company sells its products through CVS/pharmacy retail stores and online through CVS.com. CVS Caremark also offers pharmacy benefit management services, including mail order pharmacy; specialty pharmacy; plan, design, and administration; formulary management; claims processing; and reinsurance services to managed care and other organizations.

Market capitalization is $55.39B.

Company Fundamentals:

I like to evaluate management by having a look at the return on invested capital (ROIC) and the return on equity (ROE).

The ROIC has been declining over the last 10 years. Back in 1997, the ROIC was 18.2%. It has slowly decreased along the way and last year’s ROIC was 10.7%. The 5 year average ROIC is 11.4%.

The ROE has been more consistent. Although in the early years, ROE of 16% was being achieved, it seems to have leveled off in the 13% range. The 5 year average ROE is 13.2%.

Equity growth rate has been trending upwards which is a great sign. The 9 year rate is 14.13%. The 5 year rate increases to 15.43%. The 3 year rate climbs higher at 16.5% and last year’s equity growth rate was 17.37%. Nice upward trend.

Earnings per share growth rate has been a bit erratic. The 8 year rate is 10.42%. The 5 year rate increases to 15.2%. The 3 year rate comes in at 16.71%. Last year’s EPS growth rate dropped to 12.23%.

Sales growth rates have been trending upwards very nicely. The 9 year rate is 13.48%. The 5 year rate is 14.72%. The 3 year rate comes in at 18.4% and last year’s rate holds steady at 18.4%.

A mixed message from these fundamentals. The declining ROIC and erratic EPS growth rates are balanced by the consistent ROE, nice equity growth rates and sales growth rates.

Dividend Fundamentals:

The current dividend yield is 0.63%. I consider that a below average yield compared to the S&P 500 Index dividend yield of 2% and the Dow Jones 30 Index dividend yield of 2.37%. However, low current yields can be acceptable with excellent dividend growth rates.

But the dividend growth rates are not exceptional. In fact, there were no dividend increases between 2000 and 2003 inclusive! That is 4 years without any raises. Of course, that just kills the averages. The 9 year rate is 3.44%. The 5 year rate is 6.87%. The 3 year rate comes in at a healthy 10.6%. But last year’s dividend growth rate dropped back to 6.9%.

One good sign is the ultra low dividend payout ratio. It has remained very low over the 10 year period reaching a high of 17.78%. And it has steadily decreased to last year’s low payout ratio of 9.94%.

Cash flow growth rates have remained very steady. The 9 year rate is 16.66%. The 5 year rate is 16.3%. And last year’s rate was 15.74%.

The fact that management did not raise dividends for 4 of the last 10 years definitely knocks this company out of contention for our portfolio of superior dividend yielding stocks.

Valuation Models:

It is now time to determine a fair price to pay for this stock using our 3 models.

From the average high dividend yield model, we will use the historical high dividend yields to determine a model price. In this case, the 10 year average high dividend yield is 0.86%. The 5 year average high dividend yield is 0.82%. If I demand a yield of 0.86%, then my model price works out to $28.06. At the current price of $37.83, Mr. Market is demanding a premium of 34.8%.

Benjamin Graham would consider this stock even more severely overpriced. The Graham number works out to $21.29 which implies a premium of 77.67%. Even our new modified Graham number comes in at $24.59 which is well below the current price of $37.83.

Using my discounted present value method, I used the following inputs:

future EPS growth rate of 14.13% (Determined from the 5 year equity growth rate numbers. This was more conservative than the analysts’ estimate of 15%).

future P/E of 18.02 (This is the 5 year average P/E and is lower than the current P/E of 22.25.)

dividend yield of 0.86%

future dividend growth rate of 6.87% (Taken from the 5 year dividend growth rate which is inline with last year’s dividend growth rate.)

With this information, my model price works out to $31.47. Of course, at this price I do not earn my minimum dividend yield of 0.86%.

Here is my dividend analysis of CVS.

Here is the 1 year stock price chart:

It looks as though we could have bought it at our average high dividend yield model price in November 2006.

Conclusion:

Stocks that make it into the portfolio of superior dividend yielding stocks must exhibit commitment to ever increasing dividends on a year by year basis. CVS’s failure to increase the dividend over a 4 year period definitely knocks it out of contention. This also makes it harder to estimate a future dividend growth rate for this company.

Full Disclosure: I do not own shares in CVS.