Aetna enters a new phase in its history as it becomes a part of CVS (NYSE:CVS). With the fourth-largest insurer combined with the country’s largest stand-alone pharmacy, the lines between insurer and drug provider have become blurred. Investors want to know how this dynamic will affect CVS stock.
Only time will answer that question. However, the potential for cost savings for both CVS and its new insurance members probably makes this merger a chance worth taking. With CVS stock trading at a low multiple, I think the equity owners of CVS can benefit as well.
Market Conditions Bring Pharmacies, Insurers Closer
The dynamics that have brought Aetna and CVS together have manifested over decades. When Medicare began in 1965, it did not occur to its creators to include prescription drugs. At that time, these medications did not cost a lot, and family-owned pharmacies dominated the landscape.
Rising drug costs necessitated both corporate pharmacy empires and the insurance coverage to help pay for these medications. The insurance component expanded when Medicare introduced drug plans in 2006.
Today, with the CVS-Aetna merger, insurers and retailers have now become the same. Such a move changes the dynamics of the pharmacy business in addition to giving CVS a degree of diversification away from retail.
This has also prompted similar moves by competitors. Walgreens Boots (NYSE:WBA), the second-largest pharmacy retailer, and Humana (NYSE:HUM) have discussed a deal to take equity stakes in one another. Also, Amazon (NASDAQ:AMZN) bought Pillpack, an online pharmacy. Amazon has also partnered with JPMorgan Chase (NYSE:JPM) and Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B) to insure their employees.
CVS Stock Holds Potential Amid the Risk
Investors have a huge incentive to take a chance on CVS stock with this merger. Its current 11.3 price-to-earnings (P/E) ratio comes in well below the average 19.5 P/E the stock saw over the last five years. It also holds a guaranteed book of business with Aetna’s 13.1 million pharmacy benefit management service members.
Moreover, with this alliance, CVS can lower the cost of obtaining prescriptions for many patients. It will also hold more negotiating power over the largest drug makers. Perhaps CVS might attempt to strongarm pharma companies in the same way Walmart (NYSE:WMT) pressures suppliers to lower costs.
Either way, it will bring efficiencies that did not exist before.
The risk with this comes in combining different companies that bear little commonality to one another outside of their involvement in prescription drugs. Such a merger would have likely not occurred in an environment of lower drug prices.
Still, this is not 1965. The market conditions of today have made this merger a compelling value proposition. Time will tell whether consumers like and benefit from this model or if they turn away from Aetna due to the subsidiary’s favorite pharmacy. However, the low P/E ratio for investors and the cost savings for the company will likely make this beneficial for holders of CVS stock.
Final thoughts on CVS and Aetna
A low P/E ratio and a tempting value proposition should draw investors into CVS stock. The world of high prescription-drug costs changes many market dynamics. By combining the insurer and the pharmacy, a great deal of potential exists to lower prices for all parties involved. The alliance can also lower the costs of obtaining prescriptions for patients. Moreover, this guaranteed book of business should also give CVS more negotiating power with pharma companies, thus reducing their costs.
Investors can benefit as well. CVS stock trades at a much lower P/E ratio than the stock’s historical averages. Hence, prospective buyers could profit by taking a chance on CVS.
The deal comes with some risks. Health insurance and drug retailing remain very different businesses. By buying now, investors will take the chance that CVS can run both businesses well. The arrangement will also have to appeal to the insured. While the cost savings could help in this area, winning over consumers remains far from guaranteed.
Still, if the merger offers both better access to needed drugs and lower costs, I think both consumers and owners of CVS stock will benefit from a CVS-owned Aetna subsidiary.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.