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CVS Is Healthier than Its Valuation Indicates

By Bradley Freeman – May 12, 2020 at 5:35PM

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CVS’s transformation works to widen its competitive moat.

Wall Street's first quarter earnings results suggest financial guidance and forecasting is now voluntary. With many reports still to come, over 20% of publicly traded companies chose to withdraw all profitability and sales projections. Understandably so. The coronavirus pandemic has spurred severe health and financial hardship, leading to uncertain futures for many.

Yet through this all, health conglomerate CVS (CVS -0.62%) maintained financial targets for the year, confirming to shareholders a very compelling valuation.

Doctor holding a heart shaped object.

Image Source: Getty Images.

The modest stock valuation

Based on their first quarter results, CVS trades under 9x the midpoint of their profit projections. The stock changes hands at a strikingly low free cash flow multiple under 8 times the midpoint estimate. Even more captivating, CEO Larry Merlo coordinated growth in revenue and profit at 8% and 15% respectively for the quarter. A caveat, this growth was aided by transitory supply hoarding. Even after accounting for this transitory situation, however, Merlot showcases growth comfortably pacing an S&P 500 with negative quarterly top and bottom-line growth thus far.

While these fundamentals in isolation are mouthwatering, good value alone does not orchestrate stock gains. A company's long-term viability is equally important. Pharmacies and the rest of the brick and mortar retail cohort face an existential threat to viability in the form of e-commerce. Amazon and several start-ups continue to actively build out prescription delivery services.

Merlot's company partnered with UPS to develop the same service which grew exponentially this quarter. Regardless, brick and mortar is increasingly threatened by the internet. Failure to appropriately react could render a pharmacy chain obsolete. I am confident CVS is taking appropriate action to diversify their business and endure this new competition going forward.

How?

Bringing more value to consumers

Over the past several months, CVS has worked to transform its retail footprint. In their HealthHubs project, CVS converted stores to now function as a health service center. Ranging from blood work to chronic illness checkups, some stores will be able to replace routine visits to the doctor's office as a community health center for affordable consultation. None of these services can be emulated by e-commerce.

For the roughly 30 million Americans without health insurance, and for countless others in need, HealthHubs fill a huge need at a lower cost than going to the doctor. CVS is within two miles of most Americans' households -- and will eventually make these vital services more available. As of now, the program has only been rolled out in Tampa Bay and in parts of Texas. The results? Same store sales outperforming old store models, rapid adoption of Hub services, and even increased sales for traditional product lines like toiletries. While the coronavirus forced CVS to slow expansion, HealthHubs seem to be working and help immensely in shifting CVS to a business model more shielded from competition.

To enhance the value proposition of these HealthHubs even further, CVS purchased the insurance company Aetna in 2018. The vertical integration allows Aetna to access CVS's vast customer base while providing care options to them at a lower price than previously possible. Ranging from filling prescriptions to now offering services provided by the HealthHubs, CVS has actively used the purchase to widen their moat via great value for consumers. To sum it up, the Hubs enable CVS to serve a wider range of needs that e-commerce cannot, while Aetna allows them to do so more cost effectively.

Keeping up With the Times

Merlo fixates on not leaving any holes (or what he calls "white space") in the business for competition to interrupt. The new stores and Aetna integration help to plug potential gaps. But the pandemic more explicitly revealed another potential hole by inducing accelerated remote living trends.

For CVS's world, telehealth, also known as remote consultation, is the answer. CVS boasted 600% growth in their MinuteClinic destinations during quarter one this year. That is not a typo: stay-at-home orders translated into skyrocketing demand for its walk-in clinics. And while other companies like Teladoc exist to help people stay at home or avoid going to an urgent care, there is still plenty of growth opportunity for CVS to capture. Mind-boggling growth from this segment of the business depicts their strong capacity to gain from shifts in behavior. Just like the services offered at their new stores, this growth is not threatened by e-commerce.

For most of retail, the internet is a very real threat to existence. For CVS however, smart acquisitions, the intriguing HealthHub project, and Telehealth growth offers comfortable protection. The stock could inexplicably go lower in the near term, as coronavirus continues to shake investors. If it does, I would use that as an opportunity to add to my position, as this company is nicely set up for a long, long time.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Bradley Freeman owns shares of CVS Health. The Motley Fool owns shares of and recommends Amazon and Teladoc Health. The Motley Fool recommends CVS Health and recommends the following options: short January 2022 $1940 calls on Amazon and long January 2022 $1920 calls on Amazon. The Motley Fool has a disclosure policy.

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