Wall Street has seen some of the craziest times in the year 2020. Many technology stocks saw a dramatic increase in share prices, and many mature companies reported lackluster share price performance.
CVS Health (CVS 4.35%), a leading pharmacy benefit manager (PBM) with broad retail pharmacy presence and a health insurance provider, has already lost about one-fourth of its market value in 2020.
Investors are concerned about the impact of a potential Democratic win in the presidential elections over drug prices and on PBM margins. CVS Health is also burdened with total debt of over $92 billion, with a significant portion attributed to the $69.0 billion Aetna acquisition completed in November 2018. The reduced retail pharmacy footfall during the first half of fiscal 2020 has affected front store sales, which usually includes high margin products such as cosmetics and other consumables. The overall market sentiment has also turned for the worse, as the U.S. gets ready to battle the ongoing surge in COVID-19 infections.
While I am definitely not underplaying any of these investor worries, I still see robust upside potential in this stock. Here are four reasons why healthcare investors can consider picking up a position in CVS Health.
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COVID-19 has emerged as a net positive
The COVID-19 pandemic has been a mixed bag for CVS Health. On one hand, the decline in health provider visits, social distancing measures, and shelter-at-home restrictions led to lower new therapy prescriptions and reduced front store sales in the second quarter. CVS Health also reported an increase of ~ 240 million in COVID-19 related expenses in its retail and long-term care business.
Despite these headwinds, CVS Health has estimated the overall favorable impact of the pandemic on its second-quarter GAAP diluted and adjusted diluted earnings per share (EPS) to be in the range of $0.7 to $0.8.
The positive trend will most likely continue in the next few quarters, as CVS Health continues to increase penetration in the COVID-19 testing and vaccination landscape. The company currently accounts for 70% of the testing done in the retail setting and is planning to add around 1,000 rapid-result test sites by end of 2020. Till October 28, the company had performed 5 million COVID-19 tests.
The Trump administration has also entered into a deal with CVS Health and Walgreens Boots Alliance (WBA 27.55%) for administering coronavirus vaccine to long-term care facilities. CVS Health is well-positioned to capitalize on the emerging vaccination opportunity based on its broad retail presence with over 9,900 stores and around 1,100 MinuteClinic walk-in medical clinics.
Mail-order pharmacy and urgent care are promising opportunities
With customers reluctant to visit retail stores to fill their prescriptions, CVS Health's mail-order pharmacy has assumed greater importance in 2020. While revenues earned by the company's retail pharmacy network declined year-over-year (YOY) by 4.3% in the first half of fiscal 2020, mail order pharmacy revenues were up by 12.9% in the same time frame.
CVS Health's rapidly expanding MinuteClinic network will also play a major role in establishing the company in the urgent care market. According to MARKETSANDMARKETS , this opportunity is growing at a compounded average growth rate (CAGR) of 5.3% from $19.2 billion in 2017 to $25.9 billion in 2023.
Improving balance sheet and robust cash flows
CVS Health has been focused on repaying and refinancing debt, in order to lower interest expenses and make the debt maturity schedule more manageable for coming years. Since June 30, 2020, the company has repaid $2.7 billion debt and has refinanced debt worth $6.0 billion due 2023 and 2025.
Since completing the Aetna acquisition, CVS Health has managed to reduce its total long-term debt from its peak of $71.4 billion at end of 2018 to $66.6 billion as of September 15, 2020. The net debt has reduced by $11.7 billion since the closing of the transaction.
The company's total cash asset on the balance sheet has more than tripled from $4.3 billion at end of 2018 to $15.1 billion at end of June 2020. Robust cash flow from operations (CFO) has played a key role in increasing the company's cash balance. In the second quarter, the company generated a CFO of $7.1 billion and now expects fiscal 2020 CFO to be in the range of $11.0 billion to $11.5 billion. Rating agency Moody's expects the company to use all of its free cash flow to reduce its debt-to-EBITDA ratio to 3.7 by end of fiscal 2020. CVS Health is also committed to reducing this leverage ratio to low 3x's in 2022.
CVS Health's current dividend yield stands at 3.6%, while the trailing twelve-month (TTM) dividend payout ratio is only 28.2%. With less than one-third of profits used as dividends, the company has sufficient flexibility to continue paying dividends in future quarters. Besides, improving the balance sheet bodes well for a company's dividend policy. During the announcement of the Aetna deal, the company had announced a halt in dividend growth and had suspended share repurchases so long as the debt-to-EBITDA ratio is not less than 3.0. As the company comes near its target leverage ratio, the chances of reversing this policy remain high.
Yet, valuation is pretty cheap
CVS Health is trading at a forward price-to-earnings (P/E) multiple of only 7.4 . Peers including United Health Group (UNH -0.73%) and Anthem (ELV -0.55%) are trading at forward P/E multiples of 16.6 and 10.7 respectively.
Considering CVS Health's market-leading PBM, diversified business model, rapidly declining debt, and much lower multiples as compared to peers, there is significant upside potential in this stock. Based on its risk-reward proposition, CVS Health looks like a solid value pick for healthcare investors with average risk appetite.
