What Is Wrong With CVS Health Corp (CVS)?

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CVS Health Corp (NYSE:CVS) was supposed to be one of the last slam dunks left in retail. Everyone needs their drugs, right? As we age, we need more drugs. That means we need drug stores. And since CVS also owns Caremark, one of the largest pharmacy benefit managers, they should have guaranteed order flow even if I want the drugs mailed to me.

But something happened on the way to retail nirvana. CVS stock has dropped almost 26% over the last year. Since the start of 2017 it’s down 1%, essentially flat.

That is not the story told by financials. The company managed nearly 12% growth year-over-year for its December quarter. Net income was up almost 14% year over year. Operating cash flow has been rising steadily and passed $10 billion in 2016. The company has 25% of its assets subject to debt, thanks to its 2015 purchases of Omnicare and the Target Corporation (NYSE:TGT) retail pharmacy business.

A Problem of Margins

Since the Target deal, CVS stock has gone from being overvalued to undervalued. That’s what Guggenheim Securities says, and they have a $90 per share price target.

That’s small comfort to those who bought in at over $100 per share a year ago.

Still, a lot of people are pounding the table for CVS. Analysts like both the stores and the specialty pharmacy operations. One analyst says a short squeeze is on.

But this is not as easy a business as some think. CVS recently lost a $2.8 billion federal contract.  CVS faces new competition from Wal-Mart Stores Inc (NYSE:WMT), including a plan to let customers refill prescriptions via their mobile apps.

Keeping its pharmacy pipeline growing is essential to CVS, which derives 75% of its revenue from prescriptions. The company is telling anyone who will listen that its margins are minuscule, almost nonexistent.

Maybe that is a play for political sympathy, or maybe that’s the truth.

Taking the Loss

I bought into the growth story, and I paid for it, finally selling out a position in CVS stock recently at a substantial loss.

CVS stock chart

The fact is that drug stores can be dis-intermediated, not just by giants like Walmart but by smaller players. These pharmacies are taking huge chunks of market share and are starting to pack pills in doses, meaning the savings come with service.

Analysts continue to be bullish on CVS, with 17 rating it a buy against just 7 who call it a hold. However, their estimate on earnings (due May 7) are modest, $1.10 per share on sales of $44.98 billion.

That seems to be the root of the problem. Retail margins on pharmaceuticals just aren’t very good. CVS is drawing just 4% of its revenue to the bottom line, about the same as Walmart and Costco Wholesale Corporation (NASDAQ:COST). Growth is increasingly hard to come by — CVS revenues for the first quarter will trail those of the last quarter.

Bottom Line on CVS Stock

Given the reality of the retail pharmacy market, it’s amazing CVS has been doing as well as it has. The drugstore chain is the largest in the U.S. — though not for long, if Walgreens Boots Alliance Inc (NASDAQ:WBA) and Rite Aid Corporation (NYSE:RAD) merge — and the 14th largest retailer in the world. It’s playing in the big leagues.

CVS is a slow-growing company in a highly-competitive, low-margin market. The fact that it sells prescription drugs does not change that reality.

The argument for buying CVS stock is its dividend, which has more than doubled since 2013 and now stands at $2 per year, a yield of 2.6%. Income investors who bought the stock at the end of 2012, when it was at $50 per share, are now enjoying a fat 4% yield and have gotten some capital gains as well.

Just don’t buy this for fast money. CVS is slow money, an income stock, a mature company.

Dana Blankenhorn is a financial and technology journalist. He is the author of the sci-fi novella Into the Cloud, available at the Amazon Kindle store. Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. As of this writing, he did not hold a position in any of the aforementioned securities.

Dana Blankenhorn has been a financial and technology journalist since 1978. He is the author of Technology’s Big Bang: Yesterday, Today and Tomorrow with Moore’s Law, available at the Amazon Kindle store. Tweet him at @danablankenhorn, connect with him on Mastodon or subscribe to his Substack.


Article printed from InvestorPlace Media, https://investorplace.com/2017/04/cvs-health-corp-cvs-stock-what-is-wrong/.

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