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The healthcare system in the United States is organised differently than in Germany. Although services such as medication, medical treatment or check-ups may be covered by health insurance, they are not as regulated by law as they are in Germany. Health insurance companies, healthcare providers and pharmacy chains are independent companies in the United States. CVS Health (ISIN: US1266501006) combines them all in one company, i.e. health insurance, healthcare and pharmacy chains.
Source: CVS Health share price
CVS's share price has given its shareholders very little to cheer about over the past 10 years. At the end of 2014, the price was around $80, while it is currently trading below $60. However, the company has broadened its base considerably in recent years and is no longer just the pharmacy chain it was in 2014. Today, CVS Health is a diversified healthcare provider with deep roots in the American healthcare system. To this end, it has acquired several companies in recent years. As a result, its debt has increased significantly.
There has also been a recent change at the top. Current CEO Karen Lynch is stepping down and will be replaced by David Joyner. Joyner has 37 years of experience in the healthcare and pharmaceutical industry and was previously CEO of CVS subsidiary Caremark.
Could CVS Health's stock offer significantly more value than the current share price suggests, or could the mountain of debt continue to weigh on the share price? Can the new CEO use his years of experience to turn things around?
We will get to the bottom of this in our analysis of CVS Health shares.
Key facts in a nutshell
After several acquisitions in recent years, CVS Health is a broadly diversified healthcare company that includes the pharmacy chain that started it all. CVS stands for 'Consumer Value Store' and was founded as such in Lowell, Massachusetts, USA, in 1963. Initially it sold health and beauty products. Just one year later, the name was changed to CVS. Other companies were acquired early on, and CVS initially became an increasingly large chain of pharmacies. After the turn of the millennium, further acquisitions were made, of which the following stand out:
2007: Acquisition of Caremark, a leading pharmacy benefit manager (PBM).
2017-2018: Acquisition of Aetna, a major health insurer in the United States.
Between 2006 and 2015, CVS acquired various clinics and pharmacy stores (including Target's pharmacy stores).
So we can see that acquisitions are an important part of the company's history. To understand the importance of CVS Health to the American healthcare system, we should look at all areas of the company.
In its annual report, CVS reports its revenues in four different categories:
The distribution of revenues between the four areas is as follows.
Source: CVS Health 2023 Annual Report
CVS Health is a very large company, with revenues of around USD 358 billion last year. By way of comparison, its competitor UnitedHealth is considered the world's largest health insurance company, with revenues of $367 billion in fiscal 2023, just ahead of CVS Health.
The majority of its annual revenue, around 52%, comes from health services. The Pharmacy & Consumer Wellness and Health Care Benefits segments each account for about a third of the company's revenue. The Corporate / Other segment is negligible, accounting for just 0.1% of sales. Let us take a closer look at the three largest segments.
This is the health insurance division of CVS Health. Since the acquisition of Aetna in 2018, CVS has also been able to offer health insurance. CVS insures around 27 million people in the US through various health programmes, or as they are known in America, 'Medicare'. Eligible individuals can use programmes such as Medicare Advantage to gain access to enhanced medical services that would cost significantly more than traditional fee-for-service care.
CVS distinguishes between commercial medical and government medical:
All Medicare contracts fall into the government medical sector and accounted for 73 percent of sales in this sector last year. The federal government is therefore a very important customer for CVS.
The commercial medical sector offers self-funded health insurance. These can be private individuals or companies. The services offered include dental care, savings accounts for future medical procedures, and cooperation with various health care organisations such as Health Maintenance Organisations (HMO) or Preferred Provider Organisations (PPO).
In addition to using its own distribution channels to sell health insurance, CVS Health has an extensive network of independent agents and brokers who receive a premium for successful transactions.
The number of members has increased in recent quarters. One interesting fact stands out.
Source: CVS Health Analyst Centre
In the last quarter (30 June 2020), CVS Health insured a total of 26.97 million people. However, 18.80 million of these were in the commercial sector, which is almost 70 percent. However, the remaining 30 percent of enrollees accounted for nearly 75 percent of the sector's revenue. This again demonstrates the importance of the federal government to this segment of CVS Health.
The key to the success of this business is managing healthcare costs. Under the Affordable Care Act, health plans are required to spend at least 80 percent of their revenue, or premiums, on the cost of care for their enrollees. Many enrollees are currently catching up on surgeries that could not be performed during the pandemic years. This has weighed on health insurers' Medicare costs over the past year, and CVS Health is no exception.
Source: Analyst Centre CVS Health
The trend since the beginning of the year is particularly worrying. The Medical Benefit Ratio (MBR), the percentage of insurance premiums spent on treatment costs, is currently around 90%. In the wake of the change at the top, a warning has also been issued about very high treatment costs in the third quarter of 2024. The MBR is said to have risen to over 95 percent! This figure is clearly too high. A figure more in line with its competitors would be preferable. The industry leader, UnitedHealth, has an MBR of 85%.
This segment includes all medical and pharmaceutical services. CVS Health acts as a pharmacy benefit manager (PBM). In this role, CVS, through its subsidiary Caremark, negotiates discounts with pharmaceutical manufacturers for their drugs, thereby providing its customers with cheaper access to medicines.
PBM clients are typically health insurance companies that use PBMs to plan and manage their drug benefit. PBMs maintain formularies of reimbursable drugs. The health insurance companies pay a fee to the PBM. The PBM can then use the rebates to contract with pharmacy chains to distribute the drugs. CVS controls the entire value chain as it is a health insurance company, a PBM and a pharmacy chain.
The PBM market in the US is highly concentrated, with the three largest providers accounting for around 80 per cent of the market. CVS alone has a third of the market share (2022).
Source: Pharmacy Benefit Managers - Center for American Progress
Notably, the largest PBMs are each affiliated with a major US health insurer. Caremark, which is part of CVS Health, is followed by Express Scripts, which is part of Cigna, and OptumRx, a subsidiary of market leader UnitedHealth, with a market share of 24 percent.
But PBMs also work for other health insurers. Just last year, CVS lost a major contract with a California health plan that covers about 4.8 million people. A year earlier, Caremark lost a large contract to Express Scripts. So it appears that CVS is losing market share in this area.
In 2023, 2.3 billion prescriptions were filled through Caremark. It has a large network of pharmacies. Including CVS's own pharmacies, there are approximately 66,000 stores that can be used to distribute medications. This shows the importance of CVS Health for the provision of medicines in the USA.
However, it should also be noted that retail giant Amazon will also be using its distribution channels to supply medicines via Amazon Pharmacy from 2020. It is therefore questionable whether CVS Health's large pharmacy network is still necessary in terms of size.
Following a series of acquisitions, it also has a network of medical practices. Following the acquisition of OakStreet Health, patients in 25 states have access to 204 primary care facilities. MinuteClinic adds another 1,000 locations. CVS also offers additional services such as home visits through its Signify Health subsidiary.
Through its network of pharmacies, CVS Health not only distributes pharmaceuticals, but also serves as a drugstore that offers food and personal care products. CVS also offers a range of private label products. However, its main business is pharmaceuticals.
Source: CVS Health 2023 Annual Report
Nearly 79% of the Pharmacy & Consumer Wellness business is pharmaceutical and only 21% is drugstore. This gap has widened since 2021.
In its retail segment, CVS is heavily dependent on customers continuing to fill their prescriptions locally or through CVS Health's online services. Investors also need to take a critical look at revenues in this segment as Amazon, a very strong competitor with a large network, is disrupting this area.
Following its various acquisitions in recent years, CVS Health has taken on a lot of debt to finance these deals. This is reflected in the balance sheet.
Source: CVS Health balance sheet
Long-term debt currently stands at around $96 billion. Intangible assets have increased even more as a result of the acquisitions.
Source: CVS Health long-term debt and intangible assets
Following the acquisition of Aetna, long-term debt initially increased significantly to over $100 billion, and then declined steadily until 2023. However, after the most recent acquisitions, this figure has risen again.
The situation is even more serious for intangible assets. Since the Aetna acquisition at the end of 2018, this figure has tripled. There could be risks for investors here if these acquisitions prove too expensive and CVS has to write down the value of these assets accordingly. While this would not take cash off the balance sheet, it would reduce the overall value of the company.
Currently, there is about $90 billion of goodwill (the excess of the book value of acquired businesses) and CVS has already had to write down some of its assets by $431 million in 2021.
CVS Health's balance sheet contains some risks, with high levels of debt and intangible assets. Investors should be aware of these risks.
CVS Health's reported quarterly results were disappointing. Revenue rose 3% to $91.32 billion.
Source: CVS Health Quarterly Results June 2024
However, EBIT fell by 19 percent to around $3.2 billion, leaving net income of $1.77 billion. This was 7 percent less than a year earlier.
High treatment costs have reduced the gross margin, and a 5 percent increase in selling and administrative expenses also weighed on operating profit.
The past quarter highlights the challenges facing the new CEO. He will need to reduce operating and treatment costs while increasing sales to return the company to profitability.
Analysts remain cautious in their estimates following the management change. For the current year, sales are expected to be around $369.5bn. This would represent an increase of only about 3%.
Source: CVS Health Forecast 2024
Experts expect high healthcare costs to continue to weigh on margins for the full year. The EBITDA margin is expected to be only 4.50%, down from 5.60% last year. The high healthcare costs are particularly reflected in the net margin, which is expected to be only around 1.7%.
These are not healthy margins for a company with a solid dividend policy and a high level of debt. Improving profitability on a sustainable basis should therefore be a priority for the new CEO.
Source: CVS Health outlook 2024
Analysts expect sales growth to remain in the mid-single digits for the next few years. This would be a healthy increase for a company of this size. Profitability, however, is likely to come to the fore.
Source: CVS Health Forecast 2024
With a net margin of only around 1.70% this year, every percentage point would be a significant boost to profits.
And that is exactly what analysts expect over the next few years. As a result, net income could grow faster than sales. The $6.2bn net profit expected in 2024 is expected to rise to almost $12bn by 2028. If the forecasts are correct, this would almost double.
A turnaround with a new CEO will take time. However, this could be an opportunity for patient investors. If the new CEO is successful in managing costs, the estimates could prove to be too low.
CVS Health is currently a top performer in the Dividend Strategy with a score of 12. Although CVS faces some challenges, investors have always been able to rely on its dividend payments in the past.
Source: CVS Health Dividend 2024
After not increasing the dividend for 5 consecutive years (2016 - 2021), CVS has been regularly increasing the payout since 2022.
The dividend yield currently stands at 4.71%. This is well above the average of the last few years and could be interesting for dividend-oriented investors.
Source: CVS Health Dividend 2024
The average dividend yield over the last 10 years was only around 2.60%. The average payout ratio looks very good at 42% over the last 3 years.
The continuity of dividend payments is particularly impressive. Even before the turn of the millennium, CVS paid out a portion of its profits to its shareholders, and this has been the case for the last 10 years.
Annual dividend growth of around 5.9% is good for such a heavyweight in terms of sales and market capitalisation.
At the same time, dividend payments are currently still well covered by free cash flow (FCF).
Source: CVS Health free cash flow and dividend TTM
Although free cash flow has more than halved over the past three years, the dividend still looks safe. The free cash flow payout ratio is around 60% and should fall further if the new management can cut costs.
Despite the challenges, CVS Health's dividend looks safe. This is underpinned by stable cash flows and a healthy payout ratio. Here is the opportunity for investors: if free cash flow rises towards $10bn (which would be below the highs of the pandemic years), the dividend could continue to grow in the mid-single digits.
In the meantime, investors can take comfort in a dividend yield of 4.71%.
CVS Health shares are currently trading at a discount.
Source: CVS Health Valuation Ratios
With a price-to-earnings ratio of 10, the stock does not look expensive at the moment. On the other hand, the enterprise value/free cash flow (EV/FCF) ratio of 26 looks anything but cheap.
Looking at other metrics, the price-to-book (P/B) ratio of 0.95 again points to a cheap valuation. The Enterprise Value/Sales (EV/Sales) of 0.20 also makes the stock look cheap.
The P/E ratio of 10 does not make the stock look expensive either. This discount can be explained by the high level of debt, the current challenges and the high level of intangible assets on the balance sheet.
Finally, we check whether CVS's competition is also cheaply valued.
CVS Health is often compared to Walgreens Boots Alliance as the latter is the second largest pharmacy chain in the US. However, since Walgreens has neither a PBM nor a health insurance business, we use Cigna and UnitedHealth for comparison. These companies also combine health insurance and PBM.
Source: CVS Health peer group comparison charts
On a P/E basis, CVS is valued significantly lower than its peers. Cigna and UnitedHealth are valued significantly higher with P/E ratios of 25 and 37 respectively. The EV/sales is also lower than its peers. However, Cigna is very close at 0.53 and has grown sales by 16% over the last 12 months.
Cigna has the lowest EV/FCF ratio of 14, although like CVS Health, it has seen its EBIT decline.
Only UnitedHealth shows positive growth in both sales and EBIT. On the other hand, it also has the highest valuation for safety.
CVS does not look expensive compared to its peers. However, this seems justified in the current situation. The two competitors do not have to face the same number of challenges and can report higher sales growth.
At the end of our analysis of CVS Health, we conclude that CVS has a certain importance for the American healthcare system. However, many areas seem to be in need of restructuring. Analysts currently agree and are still cautious with their price targets and ratings.
Source: CVS Health analyst price targets
After a long slide in the share price and with a new management team in place, only 11 out of 21 analysts are confident that the stock has bottomed. They recommend buying the stock. The other analysts remain critical of the stock and recommend a hold. The highest target price of USD 86 is considered optimistic. The average target price of around USD 68 is 20% above the current share price.
CVS Health's stock may appeal to dividend-oriented investors, given its dividend yield of 4.7 percent and P/E ratio of 10. On the downside, high debt, high intangible assets on the balance sheet and a high cost base are risk factors to consider. For the time being, cautious investors may want to put the stock on their watch list and wait for the new CEO's first successes. Increasing net income should be one of the top priorities. If this happens and the share price stagnates, the P/E ratio could fall further. For this reason, a P/E Alert at 8 could be useful to review the stock.
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The author and/or persons or companies associated with the StocksGuide own or may own shares in CVS Health. This article represents an expression of opinion and not investment advice. Please note the legal information.