CVS Earnings Preview: The Upside Catalysts Are Fading

| About: CVS Health (CVS)
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CVS, the retail drug store chain that is the only major competitor left for Walgreen (WAG) and vice versa, reports its calendar 4th quarter on Wednesday, February 6th, 2013, before the opening bell.

CVS had a monster run off of its August, 2011 bottom in the low $30s. In 2012, CVS rose 19% (excluding the dividend) and is up about 6% year-to-date in 2013 already.

On Wednesday morning, analyst consensus per ThomsonReuters is looking for $1.10 in earnings per share on $31 billion in revenues for expected year-over-growth of 24% and 10%, respectively.

Frankly, it is tough to find a common stock in this market with 20% expected earnings per share growth in 2013, and is reasonably valued, and CVS is now trading at 13(x) enterprise value to cash-flow (according to our spreadsheet) so the attractive valuation is beginning to fade.

Two items have boosted the stock the last 6 months:

1.) There has been a firm recovery in the PBM, or pharmacy-benefit management business, which is 54% of total CVS revenues as of the September '12 quarter, and 38% of operating profits, but with a 5% profit margin.

The PBM really suffered from company plan losses in the late 2000s and has struggled since, but is now again positively contributing to CVS operations. The recovery in the PBM was one of the events that the Street was anticipating coming into 2012, and it now looks like that has happened.

2.) The second catalyst which has been recent is the return of the virulent flu season, which drives foot traffic in the retail stores and helps profit margins at CVS. Retail drugs are the other half of CVS sales but account for 2/3rd of CVS's total profits. Retail drugs have a roughly 30% gross margin and a 7.5% to 10% operating margin.

Last winter, of late 2011 and 2012, was one of the warmest winters on record and also one of the tamest flu seasons for the retail drug store business. With 2012 and 2013's very cold and snowy winter and now with the virulent flu bug that has swept the Midwest and East Coast, the return of normalcy has been factored into the stock price.

Perhaps put another way, we wouldn't buy CVS here based on the flu season. We think that is discounted in the price. Our internal fair value estimate on CVS is $60 per share, versus Morningstar's $45 value, so i think the stock is getting into the "fully-valued" zone.

With a 6% free-cash-flow yield and steadily increasing share repurchases and dividends, CVS does a wonderful job allocating capital back to the shareholder. I love the execution and the cash-flow generation. I simply think there is more good news than bad cooked into current prices.

This 4th quarter could be very strong for CVS given the severity of this winter's flu season, and the virulent strains of flu that have surfaced in the last 60 days.

We are awaiting a pullback to own more.

Disclosure: I am 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.