Is CVS Health A Better Pick Over UnitedHealth Stock?

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We think that CVS Health (NYSE:CVS) currently is a better pick compared to UnitedHealth Group (NYSE:UNH). CVS stock trades at about 0.3x trailing revenues, compared to around 1.2x for UNH. Does this gap in CVS Health’s valuation make sense? We don’t think so. While CVS Health’s business has been impacted in the current crisis with lower footfall at the stores, the Covid testing and vaccination is aiding its top-line growth, a trend expected to continue in the near term. On the other hand, UnitedHealth has benefited from expansion of OptumHealth, which provides care through local medical groups, along with a rise in enrollments for government sponsored plans. However, there is more to the comparison. Let’s step back to look at the fuller picture of the relative valuation of the two companies by looking at historical revenue growth as well as operating income and operating margin growth. Our dashboard CVS Health vs. UnitedHealth: CVS stock looks undervalued compared to UNH stock has more details on this. Parts of the analysis are summarized below.

1. Revenue Growth

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Between 2018 and 2020, CVS Health’s revenues grew by about 38%, from around $195 billion to $269 billion, partly driven by the Aetna acquisition in 2018. Looking at UnitedHealth, total revenue grew 14% from $226 billion in 2018 to $257 billion in 2020. UnitedHealth’s revenue growth has been driven by expansion of OptumHealth, growth in prescription volume, and average billing per prescription.

2. Operating Income

CVS Health’s operating income grew from $4.0 billion in 2018 to $12.5 billion in 2020, led by revenue growth and margins expansion from 2.1% in 2018 to 4.6% in 2020. The 2018 margins were compressed due to a one-time goodwill impairment charge of $6 billion associated with the company’s retail segment. Looking at UnitedHealth, the operating income grew from $17.3 billion in 2018 to $22.4 billion in 2020, led by both revenue growth and margin expansion. UnitedHealth’s operating margins grew 100 bps from 7.7% to 8.7% between 2018 and 2020, partly due to lower medical costs. Note that several elective procedures were postponed during the first half of 2020, due to the pandemic, resulting in lower medical costs for UnitedHealth. However, this trend has now reversed, and medical costs are expected to rise in the near term.

The Net of It All

Although CVS Health’s revenue growth compares favorably with UnitedHealth over the recent years, UnitedHealth’s operating margins are better and in a clear upward trajectory, which partly explains the difference in trading multiple for both the companies. However, as the Covid-19 crisis abates, CVS Health is expected to see an increase in footfall at its stores, aiding its retail sales, while vaccination drives will aid the overall top-line growth in the near term. That said, even UnitedHealth’s business will see an uptick with an increase in corporate healthcare plans, post the Covid-19 crisis. Now, CVS Health’s stock has been weighed down, of late, partly due to Amazon’s entry into prescription medicines, and it will likely result in market share loss for CVS Health, along with other pharmacies over the coming years. However, comparing both the stocks from a valuation point-of-view, CVS Health looks better.

UnitedHealth at a current price of $334 is trading at a higher valuation of 1.1x its projected 2021 RPS of $290, while CVS Health at $69 is trading at just 0.3x its projected RPS of $213 in 2021. While the multiple for UNH stock has expanded from 0.9x in 2017 to 1.2x currently (based on trailing RPS), CVS’ multiple has declined from 0.4x to 0.3x over the same period. As such, we think this difference in P/S multiple of CVS Health and UnitedHealth will likely narrow going forward, implying better returns for CVS stock.

While CVS stock looks undervalued, 2020 has also created many pricing discontinuities that can offer attractive trading opportunities. For example, you’ll be surprised how counter-intuitive the stock valuation is for Pfizer vs Merck.

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