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CVS: A High Cash Flow Yield, But A Low Return On Capital

May 12, 2023 1:41 PM ETCVS Health Corporation (CVS)CI, RAD, UNH, WBA49 Comments
Philip Eriksson profile picture
Philip Eriksson


  • CVS is undervalued and generates impressive cash flow, but it faces competition, regulatory challenges, and low operating margins, resulting in mediocre returns on capital.
  • Before investing, I believe an investor should study the complex operations behind the storefront of CVS before falling for its cash flow yield.
  • CVS is a vertically integrated and complex company with a healthcare insurance business, pharmacy benefits manager, primary care provider, and pharmacy/retail operation.

CVS To Purchase Oak Street Health Clinics For 10.6 Billion

Spencer Platt


I have been an investor in CVS Health (NYSE:CVS) a little bit prior to the company's $69 billion acquisition of Aetna in 2018. Since then, I have been fairly confident that I understood the business - especially considering the accessibility of

This article was written by

Philip Eriksson profile picture
I believe that successful investing boils down to the following question: is this company important and why? A company's financials are or will be a reflection of that. I want to invest in companies that I believe are / will be important and hold them over the long term. I have 7 years of investing experience and ardently follow company performance. I am currently a master's student at the Stockholm School of Economics. I hope that my insights and our discussion will lead to better long-term investments.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of CVS either through stock ownership, options, or other derivatives. 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.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (49)

jimidean profile picture
Do you have a source for your "low operating margins which all result in mediocre returns on capital of 7.4% for CVS" Because the M* data i see reports much much worse returns on capital:

Management Effectiveness (TTM)

Return on Assets 1.69%
Return on Equity 5.47%
Return on Inves. Capital 2.44%
Philip Eriksson profile picture
@jimidean Aha yes, sorry for not including the source. I got it from a ISS EVA research report www.issgovernance.com/... They make research reports and put them up on fidelity (my broker). Also they mention that CVS cost of capital is around 5%. Where did you get your data btw- what is M*?
jimidean profile picture
@Philip Eriksson hi thanks, M* is short for Morningstar, their amounts were the same as reported by Morgan Stanley
Philip Eriksson profile picture
@jimidean ahh ok got it! They must be using different capital figures then? This number is generally unclear for CVS since there are many ways to measure it - maybe not the most intuitive performance proxy to use…
In their recent conference they expect to earn $9 in 2024. Growth will be slow though. So I wouldn’t put a big multiple on it. A multiple of 9-12 seems reasonable if they can monetize the latest acquisitions. So $81-$108 range, but they have to get to at least $9. They have to monetize the acquisitions. They have to improve star ratings to provide growth in out years. Lots of work to do.
Philip Eriksson profile picture
@kevn1111 yep, great insight. Growth is going to be one of the largest concerns here.
As Donald John would say lets see what happens
Philip Eriksson profile picture
@khatcher hehe, yea it’s going to be exciting!!
diroha profile picture
They have to get serious about their debt. I know they have a plan but the 2 recent acquisitions resulted in a lot more debt. Investors are not going to pay up for EPS in such a leveraged situation.
Philip Eriksson profile picture
@diroha yep, it’s really important. I think they took on around $5.7 billion in new debt now to finance these acquisitions.
@diroha had the same issue with Aetna. They did commit to lowering that debt and hit their goal, so if they commit again I will believe it. Could be a dividend halt though for 2 years...
Yuval Rotem profile picture
Thank you for referring to my article and for your interesting view as well!
I think UNH's relevant segment margins perfectly reflect the best-case scenario for CVS. At its current price, I think even the base-case scenario will reward shareholders.

On another note, CVS's total assets are inflated with goodwill. But actually, since 2018, the company barely deployed capital that resulted in goodwill. If you adjust for that, then you get to the 16%-18% ROCE range.
Philip Eriksson profile picture
@Yuval Rotem hey no problem, it’s always a pleasure to read your articles!! And really interesting insight. This makes sense when we think about their business. CVS is not investing in many new stores/pharmacies so PPE assets are actually declining w/ depreciation and Aetna + Caremark are more labor-intensive businesses. One thing I’m wondering about though… is it reasonable to include subtracting Health care costs payable (Current liability for Aetna) when calculating the ROCE?
Yuval Rotem profile picture
@Philip Eriksson I think the reason you subtract current liabilities is to reflect the capital that isn't being 'employed'. So, for lack of a better way to assess how much capital is paid back to Aetna's beneficiaries, I'd say we do need to subtract these, or else it will be a double count, as the current health care costs payable are expensed in the income statement.
Philip Eriksson profile picture
@Yuval Rotem ahh ok yep I get your thinking, thanks :)
In the end all the primary care acquisitions such as Oak Street depend on poorly trained APRNs with little to no oversight. It is an FTE job with a lot of turnover and referrals to the Er for any really sick patient. This will eat into shared risk contract profits quickly. They have very poor integration with large hospital systems and nursing homes. I also am waiting to see routine multimillion dollar judgements for medical malpractice. The formulary management is also at risk when someone brings a law suit for not using best in class drugs and patients end up with bad results. Not to mention CVS having to recall drugs because of carcinogens.
Philip Eriksson profile picture
@Maybenot2023 these are exactly the type of risks i think investors should know about!! Thanks for describing a more concrete example. And do you mean Oak Street has poor integration with hospitals? - what can we look for to see this is under control, operating margins?
@Maybenot2023 yea operating doctor's offices might scale poorly cause of deep pocket theory. Sure they carry insurance. But plantiffs will ask for way more than your insurance capacity if you have billions of dollars in cash on your balance sheet. This is where vertically integrating could make things worse maybe there is a law or legal framework that can protect from this. But I doubt it.
BeaBaggage profile picture
@johngonole this magnified potential 'legal' risk from vertical integration is nonsense-
for decades CVS has been operating in the medical field w registered pharmacists who dispense billions of RX annually- occasionally we hear about pharmacies dispensing the wrong RX to someone but on a corporate scale there are numerous checks and balances in place to thwart the issues.
You are required to sign that you were given the option to discuss your RX and potential interactions etc when you pick up- do you have any questions for the pharmacist? do you decline to discuss with the pharmacist?
I just did this yesterday.
CVS will carry this patient focused concerned culture to the vertical integration into other areas as well. Pharmacists gave out hundreds of millions of vax in the last 3 years..no class action suits, big lawsuits making headlines.

more fear mongering as usual.. professionals are required to carry E&O insurance and even corp employed ones often carry policies on their own; a relative is a hospital pharmacist and their E&O protects her and she carries a 2mil policy as well. Institutions also often employ large reinsurance policies as well.

It would require gross negligence on a corporate level to amount to anything risking the company and I don't see that here at $CVS.

the dearth of PCP MD's is real especially in rural areas and clinical care management thru other sources like insurers, pharmacies and 'clinics' is the future. CVS is prepared to move in this direction.
MWinMD profile picture
A lot of moving parts, indeed. But the person who knows them best *should* be the CEO, and she recently bought $1 M more worth of it at around $70. FWIW.
Philip Eriksson profile picture
@MWinMD Aha... interesting insight. I didn't know that, thank you!
BeaBaggage profile picture
@MWinMD long $CVS recently and adding on these dips..great value for a long term position accumulation. Bea
Philip Eriksson profile picture
@BeaBaggage agree, this is a great time to be buying if you believe in CVS.
Good article, thx! Me too got in at 97 traded around all the way to the 50s, doubled it. Was my first most hated stock second was Viacom. That’s why I sold all over 90. Don’t get married to stocks!
Philip Eriksson profile picture
@RWilliam Good timing in the short term!
@Philip Eriksson very long term hold around same as you. I cut stocks when they seem expensive and don’t fit my core hold. Redeploy the capital.

Too low div too low growth. Unlike AVGO MLPA LYB MO BTI MO QCOM EPD PRU all in my top ten list. MLPA is the only ETF I hold large amounts for tax reasons.
I got have one or the other (growth or income) or a blend. I cut ABBV. We see if I’m right on that one.
Philip Eriksson profile picture
@RWilliam ok got it. Never get married to stocks, i like that XD. You're right to sell when you don't believe in the investment thesis anymore and thanks for the tips :)
I rather use market values and FCF for ratios instead of accounting BS. Shareholders perspective: FCF = $13.5 bn | FCF/Mkt Cap = 13.5/88.4 = 15.3%. Including bondholders: Adj FCF = FCF + Interest * (1-tax) = 13.5 + 2.3*(1-.26) = 15.2. Adj FCF / EV = 15.2 / 147.4 = 10.3%. It doesn't look bad to me unless interest rates won't go lower over the next couple of years. That would increase interest expense and reduce FCF to shareholders.
Philip Eriksson profile picture
@pmapires agree with you there. How many ways can you twist and turn profitability ratios... lol? But one thing that I hold on closely too still is that CVS operates in complex industries without much insight from the investor/consumer side (Aetna's star rating was a surprise & 27% decline in operating margin at pharmacy was as well).
Let's look at this in terms of returns using Q1 23 numbers. Working capital (CA-CL) is negative, meaning there is no capital invested there, so ignore for now. Also holding a lot of cash, which one could take some out of CA. Then look at PPE $13B, but few of assets I am not going to count: 1) operating lease asset is just accounting fiction to put store leases on the balance sheet 2) goodwill and intangibles based on deals they have already done. There is $8B of other assets, don't even know what it is. So $13B + 8B in assets = $21B. Annualizing their Q1 NI is about $8.4B. So return on tangible assets is very high at 40%! Now what do you do with goodwill and intangible assets--that has more to do with capital allocation and I have no problem passing judgement on whether doing M&A and/or whether CVS mgmt overpaid for deals. My only point is that the underlying business generates a very high return.
Ray Merola profile picture
@johnhyunsookim Determining RoIC is part arithmetic and part philosophy.

One could make a good argument that goodwill and intangibles may be excluded from the calculation. However, GW and intangibles is about half total assets. These do reflect real money spent on acquisitive actions; so should not these be included in return-on-invested capital?

Using a down-and-dirty methodology and 1Q2023 input (annualized), I can come up with ~12% RoIC.

Here's the formula:

EBIT (adjusted) / total assets minus current liabilities minus balance sheet cash
Philip Eriksson profile picture
@johnhyunsookim interesting way to look at it. But I agree with Ray that CVS is especially acquisition happy and has so much goodwill its undeniable! Also, another perspective could be using the net income from pharmacy/store operations divided by the $21 since the majority of fixed assets pertain to this business unit.
@Ray Merola I've always felt that acquiring. Companies should maximize cash flows by depreciating goodwill.

And to some else's point I don't care for them putting future lease obligations on the balance sheet as assets. It is 't hard usually to subtract the long term debt carries on the liabilities side of the balance sheet but a pain that has to be dealt with when looking at financial metrics.
Ray Merola profile picture
Thank you for referencing / linking my recent CVS article.

CVS return-on-capital is greater than its WACC, so there is value creation. However, to your point, the RoIC isn't outstanding. It is greater than WBA, though less than CI or UNH. To be fair, none of these companies' business models are an overlay with CVS.
Philip Eriksson profile picture
@Ray Merola Hey, of course! I enjoyed your article and I have also seen that they have a greater return on capital than their WACC (which is surely positive). But yes, whenever I review CVS I can't get a grip of whether it truly is a great long-term investment considering all the other opportunities that there are. The company is a giant in this industry, like no other!
Tim Travis profile picture
Good article. I have a tough time understanding the strategic rationale of those recent acquisitions relative to the price paid. Maybe they are right, but that is my biggest struggle with the stock.
Philip Eriksson profile picture
@Tim Travis Well it seems like management is very optimistic about leveraging their capital position to grow Oak Street. This could be a great acquisition if the profitability of these locations are what management thinks it will be.
Millennial Investment profile picture
@Philip Eriksson vertical integration. It doesn’t take a rocket scientist to figure this stuff out. Debt is high, but is well covered by FCF. It’s going to be a struggle for the next 2 years imo. But that’s a good time to accumulate shares. 2025 will be a turnaround story (if not sooner)
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