Over the past five years, CVS Health (NYSE:CVS) handily outperformed the benchmark S&P 500 with an 80% gain, while treating shareholders to a 200% increase in quarterly dividend payments. Impressive dividend growth and a central position in America's large and growing healthcare sector suggest this stock could be a good fit for long-term retirement portfolios. However, a couple of setbacks last year could signal trouble ahead.
CVS Health's largest competitor in the retail pharmacy space, Walgreens Boots Alliance (NASDAQ:WBA) lured away an important client, and Walgreens' intended acquisition of Rite Aid (NYSE:RAD) might threaten CVS Health's ability to compete further in the years ahead. Let's take a closer look at some incoming challenges and opportunities to gauge just how risky CVS Health stock is right now.
Growing competitive threat
During the first nine months of 2016, operating profits from CVS Health's retail and long-term care segment rose about 4.1% over the previous year period, but growth from this segment in 2017 might be far more difficult than recent years. Last year, Walgreens inked a deal with Prime Therapeutics. The network of 14 Blue Cross and Blue Shield companies covers the lives of 22 million Americans. Now that they'll be steered toward Walgreens pharmacies to fill prescriptions, CVS Health's main competitor in the retail pharmacy space will enjoy an even larger footprint.
Perhaps the most troubling development for last year was the loss of Tricare's business. The network used to send roughly 9.4 million active-duty and retired military personnel, plus their family members, to CVS Health to have their prescriptions filled. Effective last December, those customers are now being steered toward Walgreens pharmacies, and CVS Health investors will want to look for signs of the fallout when the company reports fourth quarter 2016 earnings.
While Walgreens does appear to be becoming more and more of a threat to CVS, it appears the government might feed CVS Health a slice good news soon. The pending Walgreens Boots Alliance acquisition of the country's third largest retail pharmacy chain, Rite Aid, hit a widely expected snag last year when the U.S. Federal Trade Commission (FTC) insisted the two retail pharmacy chains shed hundreds of stores before it would allow the deal to proceed.
The snag became more pronounced last October, when the FTC told Kroger it wouldn't be allowed to shutter and integrate stores it had considered buying from Rite Aid. More recently, a report from Bloomberg suggests Walgreens' proposed sale of 865 drugstores to Fred's won't allow for enough competition to satisfy regulators.
Looking past the registers
Right now, it's difficult to predict how retail pharmacy competition with Walgreens will shake out. Luckily, CVS Health has been pivoting toward other services that jive with its vast retail footprint, the most notable of which is its pharmacy benefit manager (PBM).
In the first nine months of 2016, CVS Health's pharmacy services segment contributed about 45% of consolidated total operating profit, up from 42% during the same period in the previous year. Since 2013, the number of lives its PBM can claim under management has risen steadily from about 62 million in 2013 to an estimated 89 million this year.
A PBM's negotiating leverage with pharmaceutical companies (and, in turn, the value it can offer subscribers) increases with size. CVS Health contends it's the country's largest, and a 96% to 97% client retention rate suggests its nearly 30% share of America's PBM market is positioned to continue growing for years to come.
A nice price even without a tax break
The Trump administration's intended corporate tax reforms aren't fully formed policies just yet, but any relief would lead to a noticeable bottom-line bump for CVS Health. The company's operations might be diverse, but geographically it's heavily centered in America's high-tax zone. During the trailing twelve month period, the company's effective tax rate was an eye-watering 38.7%. Any tax relief would lead to a major bottom-line boost.
The fairly recent loss of Tricare and failure to sign Prime Therapeutics didn't sit well with the market, and the stock is still somewhat depressed for a company that expects to generate annual adjusted earnings growth of around 10% over the long term. At recent prices, shares of CVS Health are trading at just 17 times trailing earnings, which is far below the S&P 500 average of about 25 times trailing earnings.
CVS Health shares also offer a 2.5% dividend yield at recent prices. That might not be an exciting yield right now, but the company has increased its payout at a blazing fast 25.2% annual rate over the past five years. While I wouldn't expect the distribution to grow at such a phenomenal rate over the next five years, the company is generating more than enough cash to continue bumping up payments in the years ahead.
With a diverse revenue stream derived from leading positions in both the retail pharmacy and PBM industries, CVS Health's top line is on fairly steady ground, and strong cash flows should allow its dividend to grow at a double-digit pace. The biggest risk I can see right now is the bruise you'll get kicking yourself for not taking advantage of this healthcare gem's very reasonable price right now, especially if tax reforms lead to a big bottom line bump.