I wrote previously how WBA stock is undervalued, but also has potential to take advantage of one hour delivery of not only life saving drugs, but many of its thousands of retail items. CVS has the same equal opportunity to capitalize on one hour delivery and beat Amazon at it’s own game. However, CVS differs from Walgreens because CVS acquired Aetna in late 2018 for $69 billion.
Aetna is a managed health care company that sells traditional and consumer directed health care insurance and related services, such as medical, pharmaceutical, dental, behavioral health, long-term care, and disability plans, primarily through employer-paid (fully or partly) insurance and benefit programs, and through Medicare. The health care insurance business is at risk of being wiped out by Medicare for all legislation proposed by politicians such as Bernie Sanders. Several politicians would like to convert to single payer government funded health care insurance. The reason is to improve efficiency and transparency for patients and health care providers. A good justification that may lead to cost savings. The U.S. health insurance industry would argue that a single payer system would eliminate competition and lead to higher cost.
So how has this impacted CVS? CVS stock peaked at $112.94 on July 30th, 2015 and since then it has been a gradual trend down. After the acquisition of Aetna, CVS stock plunged. It appears, investors didn’t like the idea of CVS acquiring Aetna and with all the political rhetoric around Medicare for all and a possible Democratic sweep come November 2020, investors were probably right to sell when the acquisition was announced. Now CVS is at about $57 per share, down 49.5% from its peak. Is there still value given the risk of Aetna being wiped out? The answer is yes!
Right now if we look at free cash flow per share prior to the Aetna acquisition, $5.95 per share in 2017, we can get an idea of what CVS is worth without Aetna. On a side note, the free cash flow per share was $7.98 in 2019, which is a full year with Aetna. If we use $5.95 of free cash flow per share and assume a 8.5% discount rate and zero growth, then CVS is currently fairly valued. However, I believe CVS will at least grow near inflation of 2%, therefore its business excluding Aetna is worth over $66 per share or 16% higher. Therefore in essence an investor is getting a durable drug store business at a fair to undervalued price and Aetna for free. If single payer government funded health insurance never happens, then CVS may be worth north of $89 per share or an upside of over 56%. And by the way CVS pays a dividend of $4 per share or a yield of 3.5%, which I expect it to maintain going forward. You could hold CVS, collect the dividend and wait for the market to bid the stock price up to a more appropriate valuation.
Invest with confidence in CVS. I will be picking up more if it continues to fall in price. The analysis is too compelling. There is so much upside and very little downside, which like Walgreens is mainly related to decreasing margins from selling less retail merchandise. I believe the downside risks can be mitigated if management can capitalize on one hour delivery of drugs and retail products.
Disclosure: Long CVS & WBA
