3 Reasons Why We Like CVS After The Earnings Report

Aug. 10, 2022 3:27 AM ETCVS Health Corporation (CVS)4 Comments
Bela Lakos profile picture
Bela Lakos
417 Followers

Summary

  • Increasing revenue and the favourably updated guidance indicates the demand for CVS's products and services remain high.
  • Despite the uncertain macroeconomic environment, we expect CVS to perform well in the near term as the demand for their products/services is relatively inelastic and their FX risk is low.
  • The safe and sustainable dividend could be attractive for dividend and dividend growth investors.
  • We currently rate CVS as "buy".
CVS Pharmacy in New York City

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CVS Health’s (NYSE:CVS) share price has remained flat year to date, outperforming the broader market substantially, which has declined by as much 13% in the same period.

Chart
Data by YCharts

In this article, we will present three reasons why we think CVS’s stock could be an attractive investment in the current market environment and why we expect the stock to keep outperforming in the near term.

1.) Increasing revenue

In the second quarter of 2022, revenue has increased by as much as 11% vs. the prior year, reaching $80.6 billion. All three segments of the firm have been contributing to this growth.

  • In the health care benefits segment revenue has increased by 10.9%, reflecting growth across all product lines.
  • In the Pharmacy service segment revenue grew by 11.7% fueled by increased, pharmacy claims volume, growth in specialty, pharmacy and brand inflation, partially offset by continued client price improvements
  • The segment representing the lowest growth was the retail/LTC segment, growing by “only” 6.3% year over year. The primary drivers for this segment were: increased prescription and front store volume, including the sale of COVID-19 OTC test kits, and the impact of an extended cough, cold, and flu season compared to prior year. On the other hand, decreased COVID-19 vaccinations and diagnostic testing were partially offsetting the previously mentioned positive impacts.

We expect CVS to continue doing well and grow in the current market environment. While the pandemic fueled trends may be disappearing, we believe that the demand for the company’s products and services in general is relatively inelastic. Therefore, CVS is not likely to be materially impacted by the low or declining consumer confidence.

Performance during periods of low consumer confidence

Consumer confidence is a leading economic indicator, often used to predict near term changes in the consumer spending behaviour. A low or falling consumer confidence is likely to lead to reduced spending on durable, discretionary, non-essential goods, potentially hurting the financial performance of firms manufacturing and selling such products. But as most products and services sold by CVS are considered essential, we expect consumer sentiment to have little influence on CVS’s performance the near term.

Let us take a look how CVS’s stock price has actually developed during times of low consumer confidence in the last 20 years.

2001-2003

Chart
Data by YCharts

2007-2010

Chart
Data by YCharts

2011-2013

Chart
Data by YCharts

CVS has substantially outperformed the broader market 2 out of 3 times. Although past performance is not always useful for forecasting purposes, we believe that CVS is well-situated in the current market environment to perform well.

We believe that the performance from the period of 2001-2003 is not necessarily representative, because CVS business was going through a much more difficult times than currently, including a more than 16% decline in sales and an announcement of more than 200 store closures.

Not only us, but the management also appears to be optimistic about the rest of 2022. And this takes us to the second reasons why we like CVS.

2. Improved guidance

The firm has presented a favourably updated guidance for the rest of the year on their earnings call in August.

table guidance

Guidance (CVS)

Across all metrics, now CVS is expected to grow more than previously anticipated. Important to point out that, while according to the previous guidance adjusted operating income and adjusted EPS were forecasted to decline or remain flat, now even an increase appears to be possible.

The largest driver of the positive change was the increase in adjusted operating income in the retail/LTC segment and it already reflects updated COVID-19 assumptions and higher levels of investment spending in the back half of the year. The health care benefits segment guidance remained unchanged, while in the pharmacy services segment on the total pharmacy claims processed have been updated.

Also, as CVS mainly operates in the United States and North America, their financial performance, due to currency exchange risks and the strong USD, is not likely to be impacted directly.

All in all, we believe that the updated guidance is a positive sign and implies that the firm is confident in the continued strong demand for their products and services for the rest of the year.

In our opinion, the results of the second quarter and the guidance provided, further consolidate CVS as a market leader in the U.S. prescription drugs market.

tornado market share

Market share as of 2021 (statista.com)

And now coming to our last point: dividends.

3. Dividends

CVS has been a popular choice among investors looking for safety and dividends. The firm has been paying quarterly dividends to its shareholders since 1997, creating significant returns additionally to the realized capital gains. The company’s current quarterly dividend is $0.55 per share, corresponding to a yield of about 2.2%, annually.

bar chart dividend history

Dividend history (seekingalpha.com)

Also important to note that the current payout appears to be safe and sustainable in the near term. The following table summarizes the key dividend payout ratios.

table dividend safety

Dividend safety (seekingalpha.com)

CVS’s Dividend Payout Ratio (TTM) (GAAP) is 35% - about in line with the sector median - and about 16% below its own 5-year average.

For these reasons, we believe that CVS could be an attractive addition to dividend portfolios.

Before concluding, let us take a brief look at the valuation of the firm.

Valuation

CVS’s stock is trading at a significant discount compared to its respective sector median according to all of the traditional price multiples.

table valuation

Valuation (seekingalpha.com)

Considering that analysts are forecasting both revenue and EPS to increase in the years to come and a strong track record of recent upward revisions, we believe that CVS could be relatively safe choice at these valuations.

Key takeaways

The demand for CVS’s products and services has remained high, despite the diminishing impacts of COVID-19 induced trends.

In contrast to many firms, especially to retailers that have been struggling with inventory management and a declining demand, partially driven by a historically low consumer confidence, CVS appears to be an attractive investment option in the current market environment. The favourably updated guidance further strengthens this thesis.

The safe and sustainable dividend could make the firm appealing for dividend and dividend growth investors.

This article was written by

Bela Lakos profile picture
417 Followers
Petroleum engineer with an enthusiasm for investing, accounting and personal finances.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.

Additional disclosure: Past performance is not an indicator of future performance. This post is illustrative and educational and is not a specific offer of products or services or financial advice. Information in this article is not an offer to buy or sell, or a solicitation of any offer to buy or sell the securities mentioned herein. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. Expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. This article has been co-authored by Mark Lakos.

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