An Activist Investor Is Interested in CVS; We Take a Look

In this podcast, Motley Fool analyst Seth Jayson and host Dylan Lewis discuss:

• Why CVS has activists sniffing around, and how getting the insurance operations right could get the company and the stock back in motion.
• How interest rates are affecting the housing and auto markets, and other updates from KB Homes and CarMax.

Motley Fool analyst Jayson Moser and host Mary Long look at Uber, and its quest to become the everything app.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our beginner's guide to investing in stocks. A full transcript follows the video.

This video was recorded on Sept. 30, 2024.

Dylan Lewis: We're checking in on the way rates are hitting home and autos. Motley Fool Money starts now. I'm Dylan Lewis, and I'm joined over the airwaves by Motley Fool analyst Seth Jayson. Seth thanks for joining me.

Seth Jayson: Yeah.

Dylan Lewis: We've got another activist in the wings, and we are catching up on housing and car market data and earnings reports. Seth, as we talk here today, leadership at CVS has some visitors from Glenview Capital. The hedge fund reportedly has built up a decent stake in CVS and has some ideas for the company's management team. Sounds an awful lot like we might be looking at another activist investor here.

Seth Jayson: It's one of those stories where we get this big headline, and I guess it's the Wall Street Journal, which is then quoted all over the place. You look and there's no details of any kind. What they might want, what would you do to CVS? I haven't looked at CVS as a company for a while, so it was fun to dig in a little and see what an interesting mess it is, especially for me this weekend because I had a couple of very interesting CVS experiences as a consumer regarding the front of the store, which is one of the problems they're having. The front of the store is the non-pharmacy stuff. It's the chips and all of that stuff.

I guess maybe the medical braces that I had such a weird experience with them. They had something in there that was 28 bucks, but with the app, it was 18, and I said, can I just get it for 18 and they said, oh no, we can't do that. I was like I'll just order it on the app then and pick it up in 10 minutes. To me is telling, it gives you an example of the work they have to do in many places at CVS, but if you look at the last earnings report, the front of the store while a sales haven't been great there. The real problem for them is insurance, at least in terms of earnings. Now they're growing revenues in the insurance side of their business. Folks might not know that they on Aetna are one of the bigger insurers in the country as part of this, but the costs in insurance part of the business are not playing nice if you're a shareholder anyway.

Most of that these days appears to be simple things like not charging enough to be able to cover what you have to pay out, the ratio, but also just specifically Medicaid. The state payout hasn't been matching what they've been pricing. That's been the biggest problem.

Dylan Lewis: I think a lot of people had high hopes for the insurance portion of that business. They had acquired Aetna back in 2018, the current CEO of CVS Karen Lynch came over as part of that acquisition. I think people had assumed there was going to be a lot of expertise and maybe some more industry defining elements of that business. For them, that has not materialized. As you mentioned, that the costs have been higher. Some of that has also just been the trends of people delayed a lot of medical procedures, and are now getting a lot of those fulfilled.

Seth Jayson: They say, we're going to do better this year, we're going to price better, we got a lot of Medicare coming in, which will be better. If you read through the call, they fired the dude who was in charge of insurance. The CEO took over and then put her chief strategy officer in charge of operations at insurance. They definitely are doing a full court press on getting it right, but in the meantime, the good news is CBS is almost divisible into thirds. You've got pharmacy in the back where you and I get our pills and so forth, in front of store the chips and milk and that. That's about a third, and then insurance is about a third, and then pharmacy benefit management, where they manage pharmacy benefits for others and provide some other healthcare services. That's like 40% actually.

The other two businesses are doing OK. If you look at the financials, the story's not so bad. Their interest coverage has dwindled a little, but it's still four. This to me, the value shop should be sniffing around this, and I guess that's what we see with activists coming in.

Dylan Lewis: You mentioned that it wasn't a company you'd looked at for a little while, and you'd be forgiven for that. The company stock is essentially flat over the last five years.

Seth Jayson: Just boring. What's AI about this? Come on.

Dylan Lewis: Nothing. Not yet, at least. Shares are down this year, I think a reflection of what we're seeing with the costs on the insurance side. This is not the only time they've added activists in the mix and interested. We've seen Sachem Head Capital built a stake up earlier this year, Starboard Value built up a stake before the pandemic. Activists have been sniffing around here for a little bit. What would you want to see to feel like the ship has been righted here?

Seth Jayson: Honestly, if I'm looking at it from a value standpoint and taking initial position, I may have seen enough just in the last call. People hate it, but they seem to have made some big moves, they say, in terms of the management of that section. Then they say, we're working on that, and also our pricing should be better this year. We think we're doing better with that. If you're always taking a risk with value. They should have decent free cash flow if they can get things back where they were a couple of years ago. In the meantime, if you're somebody who looks at cheap companies, this one looks OK to me, and they've got all these locations, they're closing underperforming ones. Honestly, by the time I'd gotten done with this today, I said Geez, I might take a small position in this because I haven't played the value game for a while. There are some advantages to this company. It's hard to just buy real estate and put up a competing drugstore. It's obviously not impossible. Plenty of competition, but I don't know how many million bucks do you have to spend to open a drug store. Not a lot of companies want to roll into that, especially when the existing ones are suffering.

Dylan Lewis: We also had two company updates that flew under the radar last week that I want to pull forward this week because it gives us a chance to catch up a little bit on the interest rate game. We got KB Homes and CarMax. Why don't we start out with KB Homes. The shortage in the housing market, Seth, is, I think, fairly well documented at this point. That seems to be shown up in the numbers for KB.

Seth Jayson: KB, the stock sold off, I guess, the old story, decent performance, but the guidance wasn't outstanding. If you look at the numbers, the revenue was 1.75 billion that beat the estimates by a little bit, and they just missed on EPS, but if you look at what they're doing, they actually are selling through quite a few homes. They're doing a better job getting the homes done in a shorter time, and they think that by next year, they'll be back to about the three months that is typical from selling the thing. Getting it completed, and interest rates should help here.

Now, with new home sellers and builders, there's always a question of our interest rates going to help existing home sales more, or are they going to help the homebuilders more? At this point in time, I've got colleagues who are saying, I think the homebuilders are going to be in trouble because the lower interest rates will make it easier for existing homes to go. I can see that argument, but I don't believe that is what is going to play out because especially someone like KB, which is a little bit on the lower end of new home pricing, I think the median new home in the US now somewhere just under 480,000 somewhere in there, KBs is somewhere like 510,000. They're at the lower end of that. A lot of existing homes cost a lot more than that, and that market really hasn't come back. Existing home sales in the US generally outpace new home sales by something like 5:1 on an annualized rate.

I think that there are so many people looking for homes who've been holding off that the lower rates should help quite a bit both existing home sales and somebody like KB. I ran a little mortgage comparison just to take a look. I haven't taken out a mortgage for so long, I didn't know where the rates were. Not too long ago, we were at like 7.5% for 30 year mortgages. On an average KB home, if you paid 20% down, you'd have been looking at $2,900 a month in the payment, and that's before anything like taxes or escrow. That's just the principle and interest. You dropped that to 6.1% where we are today, and you're looking at $2,400 a month. You're almost a $500 savings. Then if you bring that down in a few months, say you think we'll be at 5.5% for those mortgages, you're down to about $2,300 a month. That's a big difference for home buyers, and I think we're going to see movement both at home builders like KB and in existing home sales if the rates continue to go down.

Dylan Lewis: To that point Seth, CEO Jeffrey Mezger said, as rates moderated in August, our net orders improved, we're encouraged by the strengthening in demand for our affordably priced homes, and the ongoing positive trend we are experiencing so far in our 2024 or fourth quarter. It seems like the company is seeing a lot of what you are also looking for with this business. What's amazing to me is in the "tough rate environment" we've been in over the last 12 months, KB Homes is up 86% for shareholders. It's been performing incredibly well while the climate has been difficult.

Seth Jayson: I own a couple of home builders. I have recommendations of a couple of them in one of our services. Almost every single one I look at is really near an all time high, and KB, collapsed a little after this, but it wasn't very much. They're still very close to an all time high. I think they were at like 91 bucks or share, and now it's 85 or something like that. They're still very close. Something like, I think, 11 times earnings for KB these days and a long term average home builder earnings multiples are always like five or seven or something. They're above that, which always makes you wonder how risky things are, except that we all know that so many Americans are looking for a home and haven't been able to buy one that the demand should still be there. Unless we see a recession, I think the demand is going to support home selling across the board. I think builders are going to do great and existing sales are going to do great.

Dylan Lewis: I want to get your take on how the rate environment plays into what we see with autos, because there's a lot of sensitivity there as well when it comes to the financing environment. We had earnings from CarMax last week as well, wanted to pull those forward. It looked like a pretty decent report. I think Topline came in a little ahead of expectations. What did you make of the results?

Seth Jayson: CarMax is another one of those companies that I think makes sense to look at as a bell weather not only for its particular industry, but for consumers as a whole. Again, that's because we think about new stuff a lot. What is Ford selling? What is Chevy selling? What's Tesla selling? But again, used cars outsell new cars by about 3:1 in the United States. That's a huge market, and CarMax is one of the biggest players in that market. Revenues there were flat, but unit sales were up about 5%. For a lot of businesses, that would mean, oh, well, your prices are going down, you're not making as much money. Sure, for CarMax, it does, mean prices were down, but CarMax in general makes the same couple thousand bucks per car, even when those prices come down. For CarMax, it really is a volume game, and it's actually a little bit better news if prices are trending down. I think are we far enough away from the pandemic car panic that we forget that used car prices went insane?

Dylan Lewis: They were totally upside down.

Seth Jayson: I was just nuts. Nobody could find any cars because the car companies all thought, no one is going to buy a car. They told other suppliers, cancel everything. What everyone said, hey, we want to buy cars they didn't have parts. You remember that mess, and then used cars went nuts. That's still unraveling. CarMax noted that there selling prices have dropped. It's almost two years straight now. Seven quarters in a row, I think comes out to almost two years. I'm willing to bet we'll get to two years. I think we're still in like 20 some thousand dollar range for their average used car, where it was like before the pandemic slightly before is about 19. I think again, the interest rate drops should help with this. Now buying a car is not nearly the leap, of course, that buying a house is, the loans are shorter and the amounts are a lot smaller, but it still does help. One of the pressures on CarMax's earnings this quarter, as opposed to the top line revenue was having to take bigger reserves in the lending unit to reflect the belief that maybe consumers will have a little more trouble paying off their loans coming up, but if we do see some trickle down in the interest rates for car loans, then that should be good news for CarMax the same way it is probably going to be good news for home buyers.

Dylan Lewis: I feel like listeners probably used to hearing us talk about that when it came to a lot of the banks over the last year, so looking at their loan loss provisions. One thing that I think would be interesting to be checking it on with this business is, as we see rates come down, does that create a little bit of upside for average selling price? Because I think a lot of folks who have been cash strapped have probably been looking for cheaper vehicles just because the financing environment's been so tough for them.

Seth Jayson: I wonder. I don't know. There's probably good research out there, but I feel like people know what a car might be worth more easily than they know what a house might be worth.

Dylan Lewis: I think there's more transparency in the auto market than the housing market.

Seth Jayson: Can comparison shop more easily. Houses are never comparable. I think for cars, again, since the amounts are smaller, the time periods are smaller, and people can comparison shop more easily, I don't think the prices should not up, but that's why we get those quarterly reports, we'll be able to figure it out in six months.

Dylan Lewis: We'll be keeping tabs. Seth Jayson, thanks for joining me.

Seth Jayson: Thank you.

Dylan Lewis: Coming up, Jayson Moser joins Mary Long for a look at Uber and its quest to become the everything app.

Mary Long: JMo, about seven months ago, Uber reported over a billion dollars in annual operating profits. CEO Khosrowshahi called it an inflection point for the company. A billion bucks is a good amount of cash, but why was this such a big deal?

Jayson Moser: Well, you're right, that is a big amount of cash. It's wonderful to see the company headed in this direction. Uber is a company that I recommended back in June of 2022 to members of our Next Gen Supercycle service. The idea was just basically listen. Uber it's everywhere. We all use it, and there's a ton of potential there. Thankfully, the stock has done well. There was a very glass half empty view on the company at that point. I think it's in regard to that profitability first and foremost, and that's why I think it is such a big deal, and thankfully, the company has performed very well since then, but Khosrowshahi even said in the call, he said that the reason why this was so important was because it proved that the business can continue to generate strong profitable growth at scale. That was the ultimate idea.

We've got this tremendous service, but how profitable can it be? Now we've seen a point where Uber has gotten to where it can be consistently and reliably profitable. Even taking into consideration, they have this investment portfolio, that quarter in and quarter out, that ebbs and flows. They realize the net gains or the net losses on that investment portfolio that they have, and that impacts their earnings number, but all in all, the core business itself continues to grow and succeed to his point, showing that this business can generate strong profitable growth at scale. I think it's a big deal.

Mary Long: Since its inception, Uber has been a ride sharing company, but it's also always had ambitions far beyond that. There was a moment. I feel like talk about this has subsided, but we might still be in the moment when the holy grail for apps was to become the Everything app. China has this and WeChat, and investors wanted to see a company become the same thing here in the states. Musk wants to do it with X, Uber wants to do it with Uber. What is the appeal of an Everything app in the first place?

Jayson Moser: Well, if you remember at one point PayPal even had the aspirations of becoming that everything or super app, I think, is what they called it. I understand the attraction there. There's a lot of convenience. You're going to one place to get everything done, which promotes ease of use. You're very familiar with it, and you just know how to go in and get your stuff done. The idea of having everything under one roof on the surface does seem like a very attractive idea, but that does come with costs.

Mary Long: Why do you think it's proven so tough to get this idea of the super app, the Everything app off the ground here in the states?

Jayson Moser: Well, I think in regard to those costs that I mentioned, like investing. There are a lot of risks that come with getting everything under one umbrella. When you put all of your eggs in one basket, well, what happens if that goes down then what do you do? Also, I think from a company perspective, beyond just the consumer perspective, but from a company perspective, it risks that Peter Lynchian term diworsification. Talking about companies that they're trying to do almost too many things. They're doing a bunch of things, and they're doing them just OK as opposed to doing just one thing or a few things really well. I think when you see in this market, particularly in the US, we see a lot of invention, a lot of iteration, and it moves at a very fast pace. We're already very used to using a lot of different apps for different things. We use payment apps for one thing, we use commerce apps for another, we use ride sharing for another. There is, I would say, probably a cultural dynamic to it as well, but I do think part of that has to do with a sandbox we're in where we just have so many different ways to do so many things in here domestically. That's a tough behavior to shift away from.

Mary Long: I'm going to have us time travel for a minute in July 2023, Josh Brown wrote a piece outlining why he thought Uber could hit $100 a share within the next 2-3 years. That's 2-3 years from 2023. The idea behind that was all about, he didn't think that X would become an everything app, but that if anyone could do it, it actually might be Uber. His large reasoning behind that was Uber already is everywhere. At the time he wrote that, this is interesting, Uber traded at about 50 bucks. Today, it's just shy of $80. I'm going to put price predictions aside and focus more on the how rather than hitting or not hitting a given number. How do you think Uber gets to where Brown and others might want it to go?

Jayson Moser: Well, I liked his points. I read that piece, and I do like his points on why he believes Uber could. I want to stress could because he stressed it as well. Could become an everything app, as opposed to something like a Twitter or X or whatever else or even PayPal for that matter. He noted that Uber unlike something like a Twitter has just a big heads start in the tech scheme of things. They've been after this for a while doing what they do very well. They have a huge user base. That's just Uber is something that most of us use at this point. It's actually a user base that continues to pay money for that service, whereas something like a Twitter, for example, would be based really solely on advertising until Musk took over and he introduced the subscription side of the business.

Then also, that revenue base gives them the opportunity really to spread those costs around and try new things, particularly when those new things are core, to what the business already does so well. When I think about Uber in its growth, I think one of the things that sets Uber apart from its competition is its ability to piece together multiple complementary business lines, and that ultimately makes the whole business stronger. There's this cross platform nature of the business, which ultimately leads to lower customer acquisition costs, higher retention rates over time. It allows them to expand relationships and ultimately come up with new things. I think you put all of that together, and it gives you an idea of why Uber is doing so well. It also gives you a vision as to why it could continue to succeed in the future.

Mary Long: I would think that the two primary businesses that come to people's minds when they think of Uber are A, the right sharing business, and then like food delivery, but where do its efforts to become an everything apps stand now? What other businesses does this company have going on that might not be the first thing that come to people's minds?

Jayson Moser: Well, I think they're taking a very thoughtful approach to that. I think that's important because they could fall into that trap of trying to do everything, and then all of a sudden, they're just doing a lot of stuff and they're just doing it OK. They're really sticking with their core business of what they do so well. I'd like that they're taking a thoughtful approach to that. I think a good example can be seen in Freight side of their business. You mentioned the mobility and the delivery side of the business, that's what most of us all know Uber for today. There is a freight side of the business right now, and that still is a bit of a question mark. They had an acquisition.

They made an acquisition of Transplace, I think it was back the end of 2021, paid just a little over two billion dollars for that, and even today, you look at Freight. Freight is still just a drop in the bucket for the business. It drives just a small part of the top line and really even a smaller part of the bottom line. That itself is still ultimately unprofitable, but I do wonder if at some point, they won't spin that part of the business off, but generally speaking, I think focusing on those core competencies, the mobility and the delivery side, and then figuring out ways to build new services around that makes the most sense for Uber.

Mary Long: When it comes to competition, again, we think of that ride-sharing business, that food delivery business. Lift and DoorDash are obvious competitors, but a less obvious competitor might be Amazon. This was flag the Financial Times just a couple of days ago published an article titled Uber's Next Act, taking on Amazon. That is a big beast to battle. Not the first company that comes to my mind when I think of who Uber's playing against. The Amazon Shopping App has 237 million monthly users. That's compared to Uber's 36.5 million users. Do you see that as being a realistic play book there? How exactly does Uber come to compete with the behemoth that is Amazon?

Jayson Moser: Well, that's always a big question we ask in regard to most businesses these days is, how is it Amazon-proof or at least Amazon-resistant? Right now, I think it's probably more reasonable to look at Uber as maybe benefiting from Amazon. Maybe not Amazon directly, although that could be part of it, but, what Amazon has done so well over many years we've been talking about it and recommending it here at the full. Amazon, just started out as books, and then they went into commerce, and then you got this AWS side of the business and all this other stuff that Amazon's doing so well, but ultimately, the core, what Amazon has done so well through time, is it's changed the value proposition for consumers, where we're less focused or maybe less focused on price and more focused on convenience. I think that convenience word is really important here because ultimately that is something that Uber does very well. Moving stuff from point A to point B, whether it's people or things, Uber is just very good at logistics and getting things from point A to point B. I don't look at Amazon as necessarily a direct competitor to Uber. They fiddle around with food delivery. Obviously, they have a tremendous logistic side of the business that serves their company very well, but you could also certainly see Uber benefiting from not only Amazon's success, but also just the consumer focusing more and more on convenience as opposed to price.

Mary Long: Another surprise part of the Uber business is advertising, and it's doing pretty well. As of the second quarter of this year, the revenue run rate from Uber's advertising business crossed a billion dollars. Is this a business segment that's worth investors paying more attention to?

Jayson Moser: I think over time, it will be. It really is a small part of the business right now. Like you mentioned, it really. It's running at a $1 billion annual run rate right now. Advertising is interesting in that it can be very profitable. Now, we don't look at Uber as an advertising business, but I would also argue that in regard to Uber's app, it does seem to fit. It seems to be a bit more native. You go into Uber's app and whether it's delivery or whether it's ride-share. Advertising just seems to fit. When you look at the $40, billion in revenue that the company is bringing in, that one billion dollar run rate is just a drop in the bucket. However, you also have to remember that is very high-margin revenue. It's something can have a bigger impact on the bottom line. Again, when you think about how advertising seems to be such a natural fit, it does make sense that they're making investments in that side of the business.

Mary Long: Jayson Moser are always a pleasure talking to you. Thanks for joining us on this one and giving us some insight into Uber and their ambitions to build the everything app.

Dylan Lewis: As always people in the program may own stocks mentioned, and the Motley Fool may have formal recommendations for or against stop buyers thing based solely on what you hear. I'm Dylan Lewis. Thanks for listening. We'll be back tomorrow.