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CVS Health Faces Rising Costs and Mounting Retail Collapse

By Alex Carchidi - Apr 22, 2020 at 11:43AM

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Investors seeking growth should avoid CVS due to the company’s dead-on-arrival new service offerings and ongoing difficulty in adapting to the pandemic.

In the past few years, CVS Health (CVS 0.15%) has ambitiously sought to expand into new markets to leverage its ubiquitous retail presence and universal brand awareness. Between the $69 billion acquisition of Aetna in 2018 and its 2019 decision to expand certain retail locations with HealthHUB offerings for primary care alongside its basic Minute Clinic services, CVS was willing to spend substantial sums to court consumers covered by health insurance who were looking for lower-cost care than offered by their primary care provider. 

With the advent of the COVID-19 pandemic, however, CVS' strategic bet on providing in-person care for routine issues is all but certain to crash and burn, curbing the prospect of rapid growth in the next few years. Here's why this healthcare stock should be avoided for the near-term.

Coronavirus testing in a car

Image Source: Getty Images

Preventive and routine care initiatives are now sunk costs

Established CVS services like Minute Clinics have become liabilities for the company as consumers delay nonessential care. Without consumers visiting its clinics, the company will incur substantial losses when its inventory of flu vaccinations and tuberculosis tests expires. Given the pandemic and the mounting likelihood of supply chain disruptions for non-COVID-19 vaccines and therapies, the company may find that even after the pandemic ebbs, new inventory to operate its clinics remains expensive to procure. Underutilized Minute Clinics will also reduce the company's return on assets (ROA), though the impact may be minor.

More importantly, CVS' HealthHUB rollout will soon grind to a halt, but the company will still be on the hook for the cost of construction and utilities without any prospect of returns in sight. Given the company's mounting $89 billion of debt exacerbated by the Aetna acquisition and the high likelihood of continued crashing revenue, the company's $8.06 billion in cash on hand also may not be sufficient to build momentum around expanding its telehealth initiatives to meet rising demand during the pandemic. This is especially true in light of the company's newfound role in providing COVID-19 testing. 

New fixed costs drive margins razor-thin

For investors currently holding shares, CVS' dividend yield of 3.21% isn't going anywhere. But, the company's thin profit margin of 2.59% will likely drop further as CVS takes on massive losses from nationwide plummeting retail volume and higher costs associated with operating new drive-through testing centers for COVID-19.

To service its new testing centers, CVS hired nearly 50,000 employees in late March while also guaranteeing that front-line employees would be paid a bonus. While the company will likely be compensated by federal or state governments for the direct costs of providing testing, it's unclear whether this compensation will cover all of the costs associated with providing testing in the first place, like expensive personal protective equipment and new training for current workers. 

It's also unclear for how long CVS will be obligated by the terms of its partnership with the federal government to maintain its testing centers as the pandemic ebbs. As its retail locations use their parking lots and other store infrastructure to provide drive-through testing, CVS may soon find that its commitment to test for COVID-19 has hamstrung any potential near-term revivals in its retail revenues. In other words, the costs that CVS took on to fight the pandemic probably don't have an upside for the company's bottom line, but they may soon have new downsides in the form of lost revenues. This will be especially true if CVS competitors like Walgreens Boots Alliance (WBA 2.36%) stop providing testing sooner than CVS does. 

What does this mean for investors?

CVS will survive the present turbulence, but it won't be a growth stock for quite some time. It's highly likely for CVS' stock to take a beating with each quarter that passes during the pandemic. In contrast, telehealth provider Teladoc Health (TDOC -3.62%) is growing rapidly, and it may be a favorable alternative for investors seeking steady gains in the short term, though its stock price is unlikely to be significantly lower anytime soon. 

Investors seeking a bargain should probably hold off on buying stock in CVS for at least a year or two when its losses have depressed the price even further from its 2015 highs. In the same vein, current holders of CVS stock should buckle up for the long run, when things start to seem more favorable for the company's retail prospects. CVS pays its next dividend on May 4, and after that, investors should pay attention to any future developments related to its payout to get a sense of how the company will treat shareholders for the next couple of years until things stabilize. 

Alex Carchidi has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Teladoc Health. The Motley Fool recommends CVS Health. The Motley Fool has a disclosure policy.

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Stocks Mentioned

CVS Health Corporation Stock Quote
CVS Health Corporation
$106.43 (0.15%) $0.16
Walgreens Boots Alliance, Inc. Stock Quote
Walgreens Boots Alliance, Inc.
$42.04 (2.36%) $0.97
Teladoc Health, Inc. Stock Quote
Teladoc Health, Inc.
$39.45 (-3.62%) $-1.48

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