CVS Health: A Healthy Stock with Some Risks

I am neutral on CVS Health (CVS) as its strong competitive positioning and steady growth are offset by an unappealing valuation and political and regulatory risks surrounding the company.

CVS originated as a massive retail pharmacy and today owns over 9,900 stores. However, in recent years it has transitioned itself into a full-service healthcare company with a recent inclusion of a leading health insurance business.

In this article, I will lay out three reasons to like CVS stock, along with a big risk that keeps me from being bullish on the stock.

Steady Growth Driven by Diversified Business Model

CVS is no longer a high-growth company but does continue to generate steady growth year after year. In 2021, its revenue grew 8.6%, and analysts expect it to grow revenue at a 6% CAGR over the next five years. Meanwhile, earnings per share saw impressive 12% year-over-year growth in 2021, and analysts forecast that it will grow at a 6.5% CAGR over the next half-decade.

In Q4 2021, CVS grew revenue 10% year-over-year and adjusted earnings per share grew 52% year-over-year. However, part of the growth was due to a short-term boost from COVID-19 vaccination and testing services at the retail pharmacy stores. In the coming years, this tailwind will likely subside meaningfully, so growth will likely slow to levels in-line with analyst forecasts.

Leading Healthcare Company

CVS enjoys a competitive position in the healthcare industry due to its attractive combination as a leading medical insurer and pharmacist. This gives it network effects, economies of scale, and name brand competitive advantages over smaller, less integrated competitors.

Its scale should also give it some pricing power with suppliers and enable it to continue opportunistically adding further services and bolt-on acquisitions to drive additional growth.

Its retail pharmacies also benefit from being in prime real estate locations. This means that many customers will choose CVS simply based on its convenient proximity to other popular locations and may also purchase additional items at its stores given the convenience provided, further padding CVS’ profits.

Unimpressive Valuation

CVS stock does not look particularly attractively priced when looking at its valuation multiples in a historical light.

Its forward EV/EBITDA ratio currently stands at 10.3x compared to its five-year average of 8.9x, and its forward price-to-normalized-earnings ratio is 12.88x compared to its five-year average of 10.40x. Its forward price-to-free-cash-flow ratio of 14.1x is also quite high relative to its five-year average of 9.9x.

CVS also pays out a dividend, which is still expected to grow in the next half-decade. However, given that interest rates are soaring, the current 2.0% dividend yield is relatively unimpressive, especially when compared to its five-year average yield of 2.87%.

According to Wall Street analysts, CVS has earned a Strong Buy consensus rating based on 10 Buy ratings, three Hold Ratings, and zero Sell ratings in the past three months. Additionally, the average CVS Health price target of $118.92 puts the upside potential at 13.9%.

Summary and Conclusions

CVS is a leading healthcare company that combines a leading health insurance business with a leading retail pharmacy business. Each business on its own would enjoy substantial competitive advantages, and together, they make the company even stronger.

While the company seems to be past its highest growth days, it continues to generate steady growth as it exploits numerous opportunities across its diversified business model. If it can continue to extract synergies and leverage its competitive advantages, CVS should be able to enjoy solid growth for many years to come.

Additionally, Wall Street analysts are overwhelmingly bullish on the stock, and the average analyst price target implies that the stock could see decent upside over the next year. That said, when comparing its current valuation multiples to its historical averages, the stock looks overvalued at present.

On top of that, CVS does have some risks. These include uncertainty about the future of the U.S. healthcare system as the political debate about how much government intervention should be enacted to make it more affordable continues to heat up.

Given that CVS is a major health insurer, it could potentially severely harm the company’s profitability depending on the details of an eventual political solution.

The most radical proposed policy solution, which was proposed by some candidates in the most recent Presidential election, would have eliminated the private healthcare insurance industry. This would have dealt an enormous blow to CVS.

Given these risks and the relatively unappealing valuation for CVS stock, investors might want to wait for a larger margin of safety before adding shares.

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