CVS Health Stock Appears Oversold At $65

After a 23% rise since the March 23 lows of this year, at the current price of around $65 per share we believe CVS Health’s stock (NYSE: CVS) looks attractive and it has significant room for growth. CVS stock has moved from $53 to $64 off the recent bottom compared to the S&P which moved 50%, with the resumption of economic activities as lockdowns are gradually lifted. While CVS stock has partially recovered to the levels it was at before the drop in February due to the coronavirus outbreak becoming a pandemic, it has significantly underperformed compared to the broader markets. Furthermore, CVS stock is also down 4% from levels seen in early 2018.

The 4% drop over the last two years or so seems surprising, given the company has seen steady earnings growth led by higher revenues and margin expansion, partly offset by an increase in total shares outstanding. The decline can largely be attributed to a contraction in the P/E multiple. We believe the stock is likely to see significant upside despite the recent uptick and the potential weakness from a recession driven by the Covid outbreak. Our dashboard, ‘What Factors Drove -4% Change in CVS Health Stock between 2017 and now?‘, has the underlying numbers.

CVS’ P/E multiple changed from 11x in 2017 to 10x in 2019. While the company ‘s P/E is 9x now, there is a potential upside when the current P/E is compared to levels seen in the past years, P/E of 11x at the end of 2017 and 10x as recent as late 2019.

So what’s the likely trigger and timing for further upside?

The global spread of Coronavirus has meant there just aren’t many people visiting doctors for non-emergency cases, and several types of elective surgeries are being postponed, resulting in lower medical costs for CVS, which translated into its MBR ratio (medical costs as % of premium revenue) declining from 84% in the prior year quarter to 70% in Q2 2020. This also aided the company’s earnings, which surged 40% to $2.64 per share on an adjusted basis, compared to $1.89 in the prior year quarter. It should be noted that this is a temporary benefit to the company. As economies open up and there is an increase in elective surgeries, the MBR ratio will also increase. From a sales point of view, CVS is expected to see a pickup in government sponsored insurance, due to high unemployment in 2020. Its retail stores sales are also trending higher due to stocking up of medicines and essentials.

Its not that benefits for CVS are limited to 2020. Given the Aetna acquisition is 2019, the company’s adjusted net margins slipped marginally (y-o-y), but this is expected to stabilize over the coming years. Aetna’s business has also seen sales improve to $37.7 billion in the first half of 2020, compared to $35.3 billion in the prior year period. Overall, we believe that CVS will likely see steady revenue and earnings growth over the coming years, and the stock trading at just 9x its forward expected earnings appears to be an attractive level for investors wiling to invest for the long-term.

Looking at the broader economy, over the coming weeks, we expect continued improvement in demand and subdued growth in the number of new Covid-19 cases in the U.S. to buoy market expectations. Following the Fed stimulus — which set a floor on fear — the market has been willing to “look through” the current weak period and take a longer-term view. With investors focusing their attention on 2021 results, the valuations become important in finding value. Though market sentiment can be fickle, and evidence of a sustained uptick in new cases could spook investors once again.  

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