2023-06-15 13:17:52 ET
Summary
- CVS has seen its shares decline to a pretty low price.
- The valuation is very undemanding.
- The yield is high, and the long-term outlook is solid.
Article Thesis
CVS Health Corporation ( CVS ) has seen its shares slump on comments from UnitedHealth ( UNH ) regarding medical costs. On top of that, CVS has recently been hit with a charge for its role in the opioid crisis. While these are headwinds, the company is so cheap that its shares nevertheless look attractive at current prices.
What Happened?
On Wednesday, healthcare company UnitedHealth's CFO John Rex made some comments about expenses in the healthcare industry. The market didn't like this statement, despite the fact that it isn't really surprising -- at least that's what I believe. As a result, UNH saw its shares drop significantly. Even worse, other healthcare companies that are more or less related to UNH, including CVS Health Corporation and Humana ( HUM ), saw their shares slump as well. CVS Health ended the day lower by 8%, with its shares hitting one of the lowest prices over the last couple of years, at less than $67. As a result, the company now looks pretty cheap compared to how it was valued in the past:
CVS Health's market capitalization is down more than 40% from recent highs, and the company's enterprise value (which accounts for debt and cash) is down by one-third over the same time frame. In just one and a half years, CVS Health's enterprise value has dropped by $62 billion. Not all of that was related to the UNH comments, of course, but the UNH comments (and the market's reaction to them) added to the already significant valuation slump CVS had been experiencing even before that.
What Did UNH's CFO Say?
UnitedHealth is a company that offers healthcare insurance and related services. It has a strong track record:
Over the last decade, UNH grew its revenue by close to 200%, and its earnings per share exploded upwards by more than 300% over the same time frame. UNH's shareholders thus have good reason to be very happy with the company's underlying performance in the recent past. UNH's CFO John Rex stated that the company was likely to experience some pressure when it comes to its medical care ratio (ratio of insurance premiums spent on healthcare expenses). All else equal, this could pressure the company's profit margin. But this does not mean that UNH's profits will decline -- underlying business growth, via the addition of new customers and via increases in the premiums the company demands, could offset the margin headwind that is forecasted by UNH's CFO. On top of that, UNH is regularly buying back its own shares, which should help offset headwinds from lower margins when it comes to the earnings per share the company will generate this year.
Even if UNH's earnings were to fall this year (I believe this is not particularly likely), they would likely not fall much -- and following a 300%+ increase in the company's earnings per share over the last decade, a small setback would hardly be a disaster.
In short, what UNH's CFO stated was not positive, but its hardly a huge issue for the company -- the exact quote, as reported by Seeking Alpha (see link above), is the following one:
I would expect that this distance that the full year would probably settle in the upper half of the existing range so that we set-up.
There is thus no unprecedented margin slump -- instead, the medical care ratio will be in the guidance range, although at the higher end rather than at the lower end. This isn't a reason for UNH to rally, of course, but it also isn't a reason for UNH investors to panic. And when it comes to CVS, there is even less reason to panic, I believe.
CVS: Punished Too Much
First, the comment was related to UNH's margin expectations, not related to the margin expectations of CVS. CVS was sold off due to being active in a similar industry. CVS did not announce something similar regarding its own guidance, thus it is entirely possible that CVS is not affected by this issue. There are several potential explanations for that, including that CVS Health's guidance may have been more conservative compared to that of UNH from the beginning. In that case, a move in the wrong direction could be fully offset by the company's guidance, leaving room for error. It's also possible that CVS does not experience similar headwinds on an operational basis, e.g. due to differences in the patients it covers, or due to benefitting from tighter cost controls.
And even if CVS were to experience the same headwinds, it is important to note that CVS is not a healthcare insurance pure play. Instead, CVS is active in other areas on top of that, such as pharmacies and walk-in clinics. That's one of the advantages of CVS' business model -- when one of its business units experiences headwinds, those can be balanced out by its other business units. Diversification helps make CVS Health more resilient versus external shocks.
All in all, I believe that the 8% share price decline following the (far from dramatic) statement by the CFO of a different company was an overreaction. The deletion of around $6 billion of CVS' market capitalization as a reaction to this news item seems way overblown to me, especially when we consider that CVS was already trading at a bargain valuation before this news emerged.
CVS And The Opioid Settlement
Not too long ago, there was another news item related to CVS. The company, together with Teva Pharmaceutical Industries ( TEVA ), Walgreens ( WBA ), and AbbVie ( ABBV ), agreed to a $17 billion national settlement regarding the role these companies played in the national opioid crisis. $17 billion sounds like a lot, but this will not be overly dramatic for these companies. First, that's the total settlement for all four companies, thus each company will only pay a fraction of that. We do not yet know how much CVS will pay, but let's assume it's one-fourth of the total, or around $4 billion. CVS has, like the other three involved companies, already set money aside for these lawsuits in the past, thus there will not be a $4 billion hit -- it was not a surprise that these companies would eventually settle these lawsuits for billions of dollars, after all. It is also possible that CVS will pay this sum over several years, which would lower the per-year impact further. CVS is forecasted to earn more than $10 billion this year, thus the sum it will have to pay should be equal to just a couple of months' worth of profit, and that does not yet account for money that was set aside for this purpose in the past.
All in all, one could even interpret the lawsuit settlement as a positive for CVS Health. After all, the issue is settled now, and the tail risk of potentially way higher costs of this legal issue has evaporated. I believe that paying a couple of months' worth of profit to get this issue out of the way is not a bad thing for CVS Health.
Final Thoughts
CVS Health has a solid long-term track record. The company is well-diversified and shareholder-friendly. Debt reduction has been successful in recent years, and the company could increase its shareholder returns meaningfully in the coming years, as its leverage keeps declining.
While CVS is not an ultra-fast-growing company, it should still generate meaningful business growth in the long run, via its investments in its operations and via industry tailwinds -- the healthcare industry is only growing larger, after all.
At current prices, CVS Health trades with a dividend yield of 3.6%, which is around twice the broad market's yield and pretty attractive. On top of that, at just 7.7x this year's expected net profit, the company's shares are very inexpensive. When a company is this cheap, not too many things have to go right -- the company is priced for a disaster, after all. But neither the comments from UNH's CFO nor the opioid settlement are a disaster, which is why I believe that investors have a buying opportunity here -- CVS Health has gotten way too cheap to ignore.
For further details see:
CVS Health: Buy The Panic