The year 2020 may have been one of Wall Street's craziest. Many technology stocks saw a dramatic increase in share prices, and many mature companies reported lackluster share price performance.
CVS Health (NYSE:CVS), a leading pharmacy benefit manager (PBM) with broad retail pharmacy presence and the operator of a health insurance provider (Aetna), has already lost about one-fourth of its market value in 2020.
Investors are concerned about the potential effect of tomorrow's U.S. presidential election, in which a Democratic win might mean big changes to drug prices and PBM margins. CVS Health is also burdened with total debt of over $92 billion, much of which came from the $69 billion Aetna acquisition completed in November 2018. A reduction in retail pharmacy visits during the first half of fiscal 2020 affected front-store sales, which usually include high-margin products such as cosmetics and other consumables. Overall market sentiment has also turned for the worse in recent weeks, as the U.S. continues to battle the ongoing surge in COVID-19 infections.
While I am definitely not underplaying any of these investor worries, I still see robust upside potential in this stock. Here are four reasons why healthcare investors can consider picking up a position in CVS Health.
1. Aspects of the pandemic have been helpful
The COVID-19 pandemic has been a mixed bag for CVS Health. On one hand, a decline in visits to health providers, enhanced social distancing measures, and ongoing shelter-at-home restrictions have meant fewer new prescriptions and reduced front-store sales in the second quarter. CVS Health also reported an increase of about $240 million in COVID-19-related expenses (such as increased sanitation and cleaning costs) in its retail and long-term care business.
Despite these headwinds, CVS Health has estimated that overall, the effects of the pandemic on its second-quarter GAAP diluted and adjusted diluted earnings per share (EPS) will be favorable, in the range of $0.70 to $0.80.
The positive trend will most likely continue in the next few quarters, as CVS Health continues to increase penetration in the COVID-19 testing and vaccination landscape. The company currently accounts for 70% of the testing done in the retail setting and is planning to add about 1,000 rapid-result test sites by the end of 2020. As of Oct. 28, the company had performed 5 million COVID-19 tests.
The Trump administration has also entered into a deal with CVS Health and Walgreens Boots Alliance (NASDAQ:WBA) to administer a coronavirus vaccine to long-term care facilities. CVS Health is well-positioned to capitalize on the emerging vaccination opportunity thanks to its aforementioned broad retail presence, with more than 9,900 stores and about 1,100 MinuteClinic walk-in medical clinics in the U.S.
2. Mail-order pharmacy and urgent care are promising opportunities
With customers reluctant to visit retail stores to fill their prescriptions, CVS Health's mail-order pharmacy has assumed greater importance in 2020. While revenues earned by the company's retail pharmacy network were down 4.3% year over year in the first half of fiscal 2020, mail-order pharmacy revenues were up 12.9% in the same time frame.
CVS Health's rapidly expanding MinuteClinic network will also play a major role in establishing the company in the urgent care market. According to one research report, this opportunity is growing at a compound average growth rate (CAGR) of 5.3%, which should bring it from a $19.2 billion market in 2017 to $25.9 billion in 2023.
3. Improving balance sheet and robust cash flows
CVS Health has been focused on repaying and refinancing debt, lowering its interest expenses and making its debt maturity schedule more manageable for coming years. Since June 30, the company has repaid $2.7 billion and has refinanced $6 billion due in 2023 and 2025.
Since completing the Aetna acquisition, CVS Health has managed to reduce its total long-term debt from its peak of $71.4 billion at the end of 2018 to $66.6 billion as of Sept. 15. That's a decrease in net debt of $11.7 billion since the closing of the transaction.
And total cash assets on the balance sheet have more than tripled, from $4.3 billion at the end of 2018 to $15.1 billion at the end of June. Robust cash flow from operations (CFO) has played a key role in increasing that cash balance. In the second quarter, the company generated CFO of $7.1 billion, and management now expects the total for fiscal 2020 to be in the range of $11 billion to $11.5 billion. Rating agency Moody's expects the company to use all of its free cash flow to reduce its debt-to-EBITDA ratio to 3.7 from close to 4 by the end of fiscal 2020. Management is also committed to reducing this ratio to less than 3.5 in 2022.
CVS Health's current dividend yield stands at 3.6%, while the trailing 12-month (TTM) dividend payout ratio is only 28.2%. With less than one-third of profits used as dividends, the company has sufficient flexibility to continue its payouts in future quarters. Besides, improving the balance sheet bodes well for a company's dividend policy. During the announcement of the Aetna deal, the company had announced a halt in dividend growth and had suspended share repurchases as long as the debt-to-EBITDA ratio is higher than 3. As the company comes nearer to its target leverage ratio, that may change again.
4. Valuation is pretty cheap
CVS Health is trading at a forward price-to-earnings (P/E) multiple of only 7.4. Peers including UnitedHealth Group (NYSE:UNH) and Anthem (NYSE:ANTM) are trading at forward P/E multiples of 16.6 and 10.7, respectively.
Considering CVS Health's market-leading PBM, diversified business model, rapidly declining debt, and much lower multiples as compared to peers, there is significant upside potential in this stock. Based on its risk-reward proposition, CVS Health looks like a solid value pick for healthcare investors with average risk appetite.