In Retrospect: CVS Health

Welcome to our stock series, where I let you in on why a company has made it on our watchlist or even in our portfolio. This time, I look back at our purchase of CVS Health.

CVS_Health_logo

On January 27, 2017 we bought 35 shares of CVS Health. At a price of €72.50 we paid €2,537.50 plus €9.90 in order fees.

What is CVS Health?

CVS Health – or CVS for short – is the largest health care provider in the US pharmaceutical sector. The history of the Rhode Island-based pharmacy and drugstore chain began in the early 1960s, when it opened its first store in Massachusetts.

After decades of expansion and several restructurings, CVS now has a nationwide network of over 9,800 retail locations and 1,100 ambulances (Retail/LTC segment). As a Pharmacy Benefit Manager (PBM), the company is also responsible for things like negotiating the price of prescription drugs for more than 94 million US Americans with health insurance.

CVS Health Sales in bn US$
CVS Health Sales in bn US$

However, like all retailers, CVS is struggling with the so-called Amazon effect, as many of its products, such as household and drugstore goods or even food, are available online at much lower prices than at its own stores. Amazon is also increasingly involved in the pharmaceutical sector. Not only has the world’s largest online retailer been licensed for prescription drug distribution in the US, but it has also partnered with Berkshire Hathaway and JP Morgan to revolutionize the US healthcare system. This is a enormous potential threat to CVS’ high-margin businesses.

Of course, CVS doesn’t stand idly by. To defend itself against the looming threat, the company intends to continue its vertical integration. A key component of this strategy is the announced acquisition of the third largest US health insurance company Aetna. This $77 billion transaction is supposed to cause annual synergies of $750 million and generate new growth opportunities by being a one-stop shop for healthcare services.

Why CVS Health?

When we decided to buy CVS in January 2017, the Amazonization of the US pharmaceutical sector still seemed far away. Sure, there were speculations about the possible entry of Amazon into online drug sales, but these had not been materialized yet. Nevertheless, CVS’ share price was already close to its 2-year low.

However, the company’s financial ratios spoke an entirely different language. Earnings per share had increased for more than 10 years in a row and its price-earnings ratio of 15 seemed relatively cheap to us. Moreover, the company had increased its dividend every year since 2003 by an average growth rate of 23% per year.

How did our investment in CVS Health turn out?

Although the stock appeared to be relatively cheap at the beginning of 2017, its chart now looks like a one-way road in the wrong direction. While Amazon’s threat to CVS’ business model got more concrete, CVS’ share price fall from €72.50 to €49.75. That’s a 31.4% discount compared to our purchase price. Now, the share price is back at €53.11. However, that’s still a 26.7% decline.

Chart CVS Health
Chart CVS Health

However, as CVS is a company from the US and we’re an investor from the Eurozone, exchange rate effects must also be taken into consideration. Since our purchase, the U.S. dollar has depreciated against the euro by 13.4%. Without this currency effect, our position would “only” be down by 15.4%. But that’s still no satisfactory performance. And it also shows that buying a stock at a temporary low is no guarantee for quick capital gains.

Chart USD/EUR
Chart USD/EUR

Is CVS Health’ stock still worth buying?

But should you still buy CVS Health’ stock today? That I want to show you based on our stock screener. So, let’s go!

How cheap is CVS?

I think a company’s stock is cheap if its current price-earnings ratio (PER) is lower than its average PER (since 2004). In case of CVS, current PER is sitting at 11.1. This is less than its long-term average PER of 15.2.

CVS Health Factor 1
CVS Health Factor 1

Therefore, CVS’ shares are currently significantly cheaper than usual. I reward this fact with 10.6 bonus points.

How strong is CVS?

I think a company is strong if it’s able to increase its profits both long-term (since 2004) and medium-term (since 2011). In case of CVS, the lower of the two growth rates is 10.9% p.a. The company’s medium and long-term earnings growth is positive.

CVS Health Factor 2
CVS Health Factor 2

Therefore, CVS seems to be a very strong company. I reward this fact with another 10.9 bonus points.

How robust is CVS?

I think a company is robust if it’s able to continuously increase its profits over the long term (since 2004). In case of CVS, the maximum year-on-year drop in profits was 26.1% (FY2018 forecast). However, the company didn’t report any loss over the entire valuation period.

CVS Health Factor 3
CVS Health Factor 3

Therefore, CVS seems to be a very robust company. I grant 2.3 minus points.

Is CVS currently a bargain?

I think a company is a bargain if its long-term trend in earnings growth (since 2004) justifies its current PER. In case of CVS, due to its robustness I would allow a PER of 15.4. This is more than its current PER (11.1).

CVS Health Factor 4
CVS Health Factor 4

Therefore, CVS’ stock seems to be a real bargain now. I grant another 4.3 minus points.

Jung in Rente Score

To calculate our personal valuation metric – the so-called “Jung in Rente” score (JiR score) – I finally sum up a company’s bonus and minus points. In case of CVS, that leads to a JiR score of +14.9 points.

CVS Health Jung in Rente score
CVS Health Jung in Rente score

Companies with a JiR score of less than -10 rarely make it on our watchlist, let alone our portfolio. With a JiR score of -10 or higher a stock qualifies itself for deeper analysis. A JiR score of 10 or higher is seen as a buy signal.

With a JiR factor of +14.9, CVS is strongly recommended for another purchase.

Dividends

Apart from our JiR score, I also consider a company’s dividend policy. That’s why, before every purchase, I not only check the current dividend yield but also have a look at the dividend growth rate and dividend track record as well as the payout ratio.

CVS Health Dividends
CVS Health Dividends

Up until now, CVS pursued a very investor-friendly dividend policy. The US-American company has increased its dividend year after year over the entire valuation period. At present, CVS pays out about 31% of its earnings, which is equal to a dividend yield of 3.2%.

However, the company announced that it would temporarily freeze its dividend to reduce the debt that will come with the acquisition of Aetna.

Conclusion

Due to its stable business model, strong earnings growth and investor-friendly dividend policy, we added CVS Health to our portfolio at a price of €72.50 back in early 2017.

Too soon, as it turned out. The speculations about the Amazonization of the US pharmacy and drugstore market sent CVS’ stock price to a multi-year low (€50.00) in 2018.

However, the decline of the stock price is not yet reflected in the company’s financial ratios. That’s why CVS Health is currently a strong buy according to our own valuation metric.

But even in the long-term, CVS Health’ business isn’t doomed to fail. With the proposed acquisition of Aetna, the company could reach an unprecedented vertical integration in the US healthcare sector.

For all these reasons, we continue to believe in CVS Health and stick to the company despite the previous price drop. Should the share price continue to decline some more, I would even consider adding to our existing position.

What do you think about CVS Health, the Amazon effect and the merger with Aetna? Please let me know and leave a short comment or contact me on Facebook or Twitter!

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