Can CVS Health Stock Offer More Upside?

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The stock price of CVS Health (NYSE: CVS) looks attractive at current levels of $76. The stock is up 49% from the level of $51 it was at on March 23, 2020, when broader markets made a bottom due to the spread of Covid-19. This marks an underperformance compared to the S&P which has moved 85% since its March 2020 lows, with the resumption of economic activities as lockdowns are gradually lifted and vaccination programs have been initiated in multiple countries. This underperformance can primarily be attributed to Amazon’s entry into prescription medicines, and it will likely result in market share loss for CVS Health. Looking at a longer time period, CVS stock is actually up a mere 5% from levels seen toward the end of 2017.

The small stock price move over the last three years or so can be attributed to unfavorable changes in the company’s EPS. The company’s revenues have trended higher, rising 45% from $185 billion in 2018 to $269 billion in 2020, primarily driven by the company’s acquisition of Aetna in 2019. While the company posted strong revenue growth over the recent years, its net margins have contracted from 3.6% to 2.7% over the same period. As such, net income grew only 8% from $6.6 billion in 2017 to $7.2 billion in 2020, despite the top-line expanding over 45%. Aetna’s acquisition also resulted in a 28% increase in total shares outstanding, and on a per share basis, the earnings actually declined 15% to $5.48 in 2020, compared to $6.47 in 2017. Despite a decline in EPS, the company’s P/E multiple has expanded from 11x in 2017 to 12.5x in 2020. While the P/E multiple has risen to 14x currently, it is likely to trend higher going forward, as the company sees improved earnings growth. Our dashboard, ‘What Factors Drove 5% Change In CVS Health Stock between 2017 and now?‘, has the underlying numbers.

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

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The global spread of coronavirus in 2020 has resulted in lower footfall at CVS stores. However, the company has benefited from the Covid-19 testing and vaccination drives at its stores, a trend expected to continue in the near term. On the health insurance side, the company is expected to see continued growth for its government sponsored healthcare enrollments. Looking at the company’s performance in Q4, its sales were up 4% to $69.6 billion, while its adjusted net margins declined to 2.5%, compared to 3.4% in the prior year quarter. This can partly be attributed to a loss on early extinguishment of debt, as well as an overall increase in operating expenses due to the pandemic. However, as the Covid-19 crisis winds down, margins are expected to improve.

Looking ahead, CVS will likely see an increase in footfall, as the Covid-19 crisis winds down. That said, any further recovery in the economy and its timing hinge on the broader containment of the coronavirus spread. Our dashboard Trends In U.S. Covid-19 Cases provides an overview of how the pandemic has been spreading in the U.S. and contrasts with trends in Brazil and Russia.

Finally, looking at the valuation, at the current price of $76, CVS stock is trading at 10x its 2021 expected earnings of $7.55 in 2021. While the 10x figure is in-line with the levels seen over the recent years, it is much lower than the 21x figure for UnitedHealth. Furthermore, as CVS sees improvement in margins, driven by its cost savings initiatives, including digitization and a reduction in real estate, this will result in better earnings growth, aiding its multiple as well.

While CVS stock may see higher levels, 2020 has created many pricing discontinuities which can offer attractive trading opportunities. For example, you’ll be surprised how counter-intuitive the stock valuation is for UnitedHealth vs Ingevity.

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