CVS Health (NYSE:CVS) - $105.47 - Sector - Healthcare- Market cap: $118.9 bnn - Beta: 1.22
CVS Heath is one of the leading integrated pharmacy service providers and drug store chain in the United States. The Company is engaged in providing pharmacy management services and retail drug sales. As of March 31, 2015, the company operated 7,850 retail drugstores, 986 health care clinics, 17 onsite pharmacy stores, 24 retail specialty pharmacy stores, 11 specialty mail order pharmacies, four mail service dispensing pharmacies, and 86 branches for infusion and enteral services, including approximately 70 ambulatory infusion suites and six centers of excellence, located in 40 states, Puerto Rico and the District of Columbia. The company was formerly known as CVS Caremark Corporation and changed its name to CVS Health Corporation in September 2014.
· CVS shares hit its 52-weeks high ($106.00) on June 18, 2015. The stock have been trending higher since earlier this week following management's announcement to strategically acquire 1,660 pharmacy drugstores and clinics from Target (NYSE:TGT) for $1.9 billion. The acquisition should enhance the company's presence across 47 states including new markets such as Seattle, Denver, Portland, and Salt Lake City to its existing portfolio. In addition, CVS will rebrand and operate TGT's 80 clinics and open 20 additional clinics in Target stores within three years, as a part of its long-term plan to function 1,500 clinics by 2017. The deal is although estimated to be dilutive to earnings by $0.06 per share in 2016, it should be accretive to earnings in 2017 by $0.10 per share and in 2018 by $0.12. Management expects the transaction to significantly enhance the company's revenues, prescription volume and operating margins in the foreseeable future.
· Acquisitions have played a significant role in shaping up the Company. CVS has grown rapidly in high growth markets, like Phoenix, Florida, Texas, California, and Arizona through strategic acquisitions. Notable deals include Osco, Sav-On, Eckerd, Long's Drug, and the most recent acquisitions of Omnicare and Target's pharmaceuticals. The purchase of Omnicare for $12.7 billion will allow CVS to strengthen its customer base in specialty care segment, catering seniors and chronic care patients (assisted living facilities and independent living communities). With aging population in the U.S., we expect this deal to be favorable for the company going forward. Management estimates the transaction to add $0.20 to its adjusted EPS (excluding integration and any one-time transaction cost) for full year 2016.
· The Company remains operationally efficient and maintains sound balance sheet with strong cash flows. CVS generated operating cash flow of $8.1 billion in 2014 and $2.0 million in the first quarter of 2015. Free cash flow was $1.6 billion in 1Q15. Full year free cash flows are expected to be in the range of $5.9 billion to $6.2 billion and cash flow from operation in the rage of $7.6 billion to $7.9 billion. Although the recent acquisitions of Target drugstores and clinics and Omnicare has raised the debt level, the company should be able to bring down its debt over time in line with its leverage target of 2.7x EBITDA. In an effort to bring down debt levels, management has already curtailed its share repurchase plan by $1 billion. We expect increased debt levels to be temporary. As of now (June 18, 2015) total debt/equity ratio of 0.35 is reasonable. Profitability ratios have been near industry average. Trailing twelve months gross margin of 18% and operating margin of 6% is near industry average of 19% and 6%, respectively.
· The company delivered solid earnings result in the first quarter of 2015. Adjusted diluted earnings were $1.14 per share, exceeding consensus estimates of $1.08 per share and 11.8% higher than $1.02 recorded last year. Net revenues increased 11.1% year-over-year to $36.3 billion led by the strength in both pharmacy services (+18.2%) and retail segment (+2.9%). Particularly strong demand for specialty pharmacy and pharmacy network claim processing (+11.0%) attributed to an increased topline growth. Revenues in the retail segment were positively impacted by comparable same store sales growth of 1.2%, driven by pharmacy same store sales growth of 4.2% offset by the decline in front same store sales growth of 6.1%. Slow consumer traffic along with recent generic drug introduction and implementation of Specialty Connect program dragged front end retail sale. In my opinion, the Company's focus on providing customers with a wide range of choices at competitive prices, innovation, and favorable demographics should yield healthy returns in the future.
· Given better-than-expected results led by strong prescription volumes, management raised lower end of its EPS guidance for the full year 2015 to $5.08 to $5.19, up from the earlier estimate of $5.05 to $5.19. For the second quarter, earnings are expected in the range of $1.17 to $1.20 per share. Consensus estimates CVS to deliver higher end of the second quarter earnings estimate.
· Technical indicators of the stock also suggest bullish trends with the stock trading 3.4% above its 50 - day moving average of $101.57 and 3.0% above 100 - days moving average of $102.02. Furthermore, CVS's MACD indicator of the stock is above 0 indicating a bullish trend.
· In my opinion, the share is a good investment for a long term period. The Company earned $4.49 last year is currently trading at a P/E multiple of 22.88x ttm earnings. Comparing this with other industry players like Express Scripts Holdings (NASDAQ:ESRX) -31.71x, Wal-Mart Stores (NYSE:WMT) - 14.62x, and overall industry average- 30.56x - the valuation appears reasonable. In my opinion, the company's ability to maintain higher operating margins despite ongoing reimbursement pressures has enabled it maintain its superior position. Higher valuation is warranted given its leading industry position and higher market share. Over the last five years, the company has traded in a range of 10.01x ttm EPS and 23.49x ttm EPS. Considering its higher market share and ability to innovate and create presence in new dimension, I expect the share to trade at the higher range of its five year P/E multiple. Assuming forward P/E ratio of 23.49 and consensus earnings estimates of $5.17 per share in 2015 I arrive at a target price of $121.
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