A Fundamental Look At CVS Health Corporation

| About: CVS Health (CVS)
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Two strategic acquisitions that will allow for significant cost and revenue synergies and will add double digit growth for top and bottom lines.

Share repurchases will reduce CVS's shares outstanding and a projected increase in dividends will return around $6 billion+ to shareholders.

Strong fundamentals and solid key ratios make this stock a compelling BUY.

The strategic acquisition of Target's Pharmacy Business and Omnicare, Inc. will allow CVS Health Corporation (NYSE:CVS) to grow market share within their core businesses as well as expand their presence in the rapidly growing specialty pharmacy market. With an aging population and a more health oriented consumer we see strong tailwinds within the specialty pharmacy market and CVS Health Corp is the best positioned company to take advantage of these trends within their peer group. The acquisitions will be accretive within the first year (2016) and will add revenue synergies in the years to come to an already robust forecast for organic growth. Top and bottom line growth is reasonable and sustainable. Recent company guidance and acquisitions offers clear visibility of EPS growth and growth in free cash flow once debt on balance sheet starts to decrease due to synergies. $6 billion were returned to investors in 2015 in the form of share buybacks and dividends. The amount which the company returns to shareholders will increase in 2016 with a $4 billion share repurchase program, management approved and a dividend increase of 20% that will be announced in the fourth quarter of 2016. Lastly CVS' double digit growth has come in a time of weak corporate earnings and has been immune to revenue volatility seen in typical retailers. Therefore it is safe to say that CVS is poised to outperform the broader market and is a sound investment opportunity, given current valuations, with clear and achievable growth.

On a year over year basis, revenues have increased 10% to a record $153.3 billion with $5.16 adjusted earnings per share, an increase of 14.8% year over year, trickling down to the company's bottom line. Management reaffirmed the 2016 guidance of $5.73 to $5.88 adjusted earnings per share, representing an expected minimum year-over-year increase of 11%. At this rate of growth CVS will surpass $200 billion in revenues by 2018.

Strategic Acquisitions

Omnicare: CVS acquired Omnicare Inc. the second half of 2015 for $12.7 billion, which factors in around $2.3 billion in debt. With the acquisition of Omnicare, CVS Health will significantly expand its ability to dispense prescriptions in assisted living and long term care facilities, serving the senior patient population. CVS Health will also expand its presence in the rapidly growing specialty pharmacy business. CVS expects to achieve significant cost and revenue synergies as well as operating efficiencies from this combination. Management expects the deal to add 20 cents to Adjusted EPS in 2016, its first full year. This excludes integration and any one-time transaction costs. Given the aging U.S. population, long term care is a growth segment of the health care system. More people are expected to use assisted living facilities and independent living communities in the coming decades, creating a substantial growth opportunity for those companies serving the health care needs of seniors. In entering this new customer distribution channel, CVS Health will deliver meaningful benefits to consumers, patients, caregivers, and payors by providing highly coordinated clinical pharmacy care across multiple treatment settings from retail to long term care.

Target (NYSE:TGT): The $1.9 billion acquisition of the 1,672 Target pharmacies should help grow the pharmacy business for more Caremark in a more capital-efficient manner. Target's 1,672 pharmacies across 47 states will be operated by CVS through a store-within-a-store format and branded as CVS/pharmacy. In addition, a CVS/pharmacy will be included in all new Target stores that offer pharmacy services. 79 Target clinic locations are in the process of being rebranded as MinuteClinic, and CVS will open up to 20 new clinics in Target stores within three years of the close of the transaction. CVS' MinuteClinic operations offers convenient access to care, with more than 1,100 locations already in existence. Here, nurse practitioners diagnose illnesses, injuries, and skin conditions, and provide a variety of wellness services. This is one key advantage CVS possesses over competitor, Walgreens Boots Alliance (NASDAQ:WBA).

Both deals will quickly and significantly raise return on invested capital.

Profitability Ratios

Return on assets (ROA) is taken into account when measuring how affective a company is at turning assets on their balance sheet into net income. CVS shines as an industry leader when it comes to ROA with 6.50 vs. 5.88 of the industry average. We also take a look at the company's return on invested capital, which to us is a far better measure as it tells us how effective management is at allocating capital to provide adequate returns. With a weighted average cost of capital of 5.1%, CVS' management is doing a phenomenal job when it comes to investing their capital to fund growth with an ROIC of 9.2%. Given recent acquisitions and the fact that the deals will start to add revenue and cost synergies as quickly as by the end of 2016 we forecast significant increases in ROIC. Credit-Suisse estimates that the ROIC of CVS can reach levels as high as 40% by 2018. CVS' earnings yield of 4.5% is significantly higher than prevailing market interest rates, specifically than that of the US 10-year Treasury yield. The earnings yield, which is the inverse of the P/E ratio, shows the percentage of each dollar invested in the stock that was earned by the company.


Our 12-18 month price target of $123 is based on a 2016 EV/ EBITDA of 10.4x, which is significantly lower than WBA at 15x. Our 12-18 month price target of $123 implies upside potential of 21%. When factoring in a $4 billion share buyback program in 2016 shares outstanding drop by nearly 40 million and we get an implied price per share of $128, which signifies upside potential of 26%. During their 52 week high, shares of CVS were trading around an EV/EBITDA multiple of 10.1x and we believe that the current EV/EBITDA multiple of 12x will contract to 10.4x due to margin dilution as well as slower Free Cash Flow accretion than WBA. The 10.4x multiple we assigned is due the fact that, on a year over year basis, net revenues and EBITDA will increase to industry highs driven by the revenue synergies that strategic acquisitions will provide.

CVS currently trades at a price to earnings multiple of 22x, which is slightly higher than the industry average of 19.6x. This current multiple takes into account only the most recent earnings announcements and since stocks are valued based upon their prospects for future earnings we believe that the forward price to earnings ratio is a better indicator to determine whether or not a stock is under or overvalued. With a 1 year forward price to earnings ratio of 15.7x CVS is trading at a discount to its industry as well as the entire S&P 500 at 18.6x and 16.8x, respectively.

Since the price to earnings multiple can be manipulated through share buybacks we also would like to examine the price to sales ratio which is a key indicator for retail companies. CVS currently commands a price to sales multiple of .7x which is significantly lower than the S&P 500's price to sales multiple of 1.7x.

DCF Valuation

Supporting Documents

  1. CVS_DCF.xlsx

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.