Despite the retail pressures, the recent sell-off in CVS (NYSE:CVS) presents a buying opportunity. To be fair, CVS has received some deserved, negative sentiment due to some changes in retail and healthcare. However, the company is at a pivotal point in its future. First, the company has excellent fundamentals, showing net income and earnings growth over the last five years. Second, the acquisition of Aetna (AET) and other innovative developments demonstrate management's commitment to evolve the company for the future. I believe more capital investment will have to be made, but CVS is transforming into a concept - not just a store. I like investing in the innovator, and I believe CVS is trying to revolutionize the doctor-patient-pharmacy relationship, and using its convenience store appeal to support it.
CVS has attractive P/E and PEG ratios. This doesn't tell us much about long-term trends, but it's an easy place to start.
It's P/E is significantly below it's 5-year, historical average. Additionally, it's PEG is .91, which is below its 13-year median of 1.32. These ratios suggests the stock is currently undervalued compared to historical earnings and expected growth. That's just math, though. Let's dig a little deeper.
Leverage is 2.25x, but stands to increase to 4.6x after completing the Aetna acquisition. I believe that to be pretty fair, since I believe the acquisition will be accretive long-term. Nearly $2B in cash provides further investment opportunity. Price/Book is <2. Its ROIC of only 12.6% tells me that it's dividend is currently more attractive than its fundamental growth. With nearly a 3% yield at a payout ratio of only 30%, this dividend achiever has an attractive dividend. The company will maintain its current dividend and cease buybacks until leverage is below 3x, but management has committed to paying down the debt quickly. Despite the pause in dividend growth, its yield is still healthy and attractive. Yield Strategist provided a thorough analysis of the dividend post-merger. Post-acquisition, CVS could become a more attractive growth play with a comfortable dividend.
The share price does not reflect the continued growth of earnings or revenue. This may suggest the market perpetually views CVS negatively, and the feedback about the merger has been mixed. That's not good news, but I believe the company is structurally changing. On a positive note, the company has overcome retail headwinds to continually grow revenues.
What's a CVS Article Without an Aetna Mention?
The acquisition of Aetna provides CVS a more diverse revenue stream to compliment it's PBM, retail, and pharmacy. This is a move that could serve as the beginning of some revolutionary changes to the company.
As a consumer, what I find most appealing about the merger is accessible, affordable, and convenient health care. While the MinuteClinic may not be a full-fledged urgent care, enough investment may turn it in to one. It's sufficient for simple check-ups, preventative care, and minor injuries and illnesses. Having the insurer, doctor, and pharmacist in a single location creates a localized, efficient, health care provider. Everything under one roof significantly reduces the costs of information collection, transmission, and time. This may lead to savings on complete health care costs, reducing costs to consumers. It also means convenience for me. No more having to run to another pharmacy. I can get my prescription and some household necessities on my way out. It's vast, geographical presence also suggests that it would be in a convenient location to quite a lot of people. No more finding a doctor or filling out information if I'm moving or traveling. I simply go to my nearest CVS. It's even open later than physicians' offices, so I can go after work.
As an investor, appeal can be found in efficiencies and related effects to its financial performance. The deal provides me confidence that management is committed to long-term vitality and growth. I'd like to see increased capabilities at the MinuteClinic, investment in technology, and a reorganization of the convenience products. CVS can position itself as an efficient, commercial partner, as well as a more convenient, modern necessity for its local consumers. My perspective on the acquisition is mostly about growth opportunity and proactive management. For a skeptical perspective, John Rhodes provided some good commentary and additional details.
Can CVS become an Innovator?
Fast Company, a media firm, placed CVS on its Top 50 Innovative Companies for 2018. The accolade was supported by a few things including ScriptPath, a consumer-freindly, "first-of-its-kind" prescription management system. Other notable items include additional services through its Pharmacy Benefits Management (PBM) system benefiting patients with diabetes. Another, less-well-known innovation is its introduction of health products vending machines being tested in 75, Northeastern U.S. locations. These would be useful in many locations, especially office buildings, apartment complexes, universities, and airports.
CVS reportedly faces competition with the greatest, retail innovator. Amazon's (AMZN) Jeff Bezos talks a lot about prioritizing the consumer. In his effort to maintain a "Day 1 Company", Amazon focuses on making the experience better for the customer. For Bezos, this means improving efficiencies in logistics, shorter delivery times, and generally being a part of every consumers' lives as a convenience. It's a daunting, but vital task, for any business to which Amazon poses a threat. To provide complete convenience to the public, it may soon provide an in-house, health care system. From insurance, to doctors' visits, to pharmacy, everything is conveniently located in a vast geographic empire of noticeable, retail locations. This innovative style of management will pay off in loyal customers, just as it has for Amazon. However, innovation is an ongoing process and can go beyond in-store health care.
The transformation in the grocery world is happening fast. While Amazon has caused some of the negative sentiment in the stock, I believe the CVS management knows it can take a page from Amazon's playbook. All this talk about convenience and accessibility is exactly what Amazon does. Need something in 2 hours? Prime Now. Need groceries delivered? Whole Foods. On your way somewhere and need a quick snack without the hassle of check-out lines? Amazon Go. CVS has these same opportunities if management wants to pursue them.
It's geographical spread and urban locations offers an easy delivery option for household necessities through services such as Door Dash or Uber Eats. It would not be difficult to develop a Jimmy John's-esque bicycle delivery option, either. If you're diagnosed in the MinuteClinic, you can just grab what you need on your way out.
Significant investment could yield another attraction to the urban hustler. Amazon, Alibaba (BABA), and JD.com (JD) have made a push into retail utilizing digital tools, information, and convenient locations. Knowing popular products and offering easy layouts to these people allows a quick, non-human exchange for healthy bites and every-day necessities.
CVS could make this transformation by reorganizing its stores, introducing a self-check-out, and including more healthy food options. For CVS, pre-made food options could be an easy addition, too. It would certainly benefit the business professional visiting a doctor during lunch, among others. Although Amazon Go just got started and doesn't have a pharmacy, the company moves fast. Fortunately, CVS already has the broad, retail landscape and pharmacy established.
CVS has the fundamentals of an attractive investment, an innovative management team willing to evolve its business, and the geographic and services capacity to compete with Amazon. As a growth investor, the merger has me changing my perspective on the company. I'm even considering its investment thesis if the U.S. health care system evolves more in the future. For instance, in a two-payer system, the government and a private insurer provide coverage. In similar circumstances, CVS would become a logical choice for its geographic footprint and all-in-one model. Under a single-payer system, the all-in-one model provides reduced administrative expenses to make it a premier choice for publicly-funded services.
5-year RSI is slightly under 40, suggesting that CVS is oversold. I find CVS to be a decent value below $70, a price it hasn't seen in four years. In 2014, EPS was 42% lower than today. I think the $57-60 mark would be an ideal entry point. I may consider initiating a small position, and adding on further downside. With its growth prospects and pending acquisition, I believe its 3% yield is an appropriate measure of market risk and substantial compared to market. This is an opportune time to buy the stock pre-acquisition.