After enjoying the $70-$80 level last year, shares of CVS Health Corporation (NYSE:CVS) fell to $55 in recent weeks for a number of reasons. Ongoing government scrutiny over drug pricing and health plans is putting pressure on the stock. Final approval for the CVS-Aetna deal is adding some uncertainties.
At these levels, what makes the CVS stock a compelling buy?
In February, The U.S. Justice Department asked a judge to approve the CVS-Aetna deal. Markets are not anticipating any other issues, other than the official sign-off. Instead, investors are more concerned over what might go wrong as CVS works through simplifying the combined firm. CVS touted a new innovative health care model that transforms the consumer health experience and builds healthier communities.
CVS certainly highlights the key areas of focus that should lead to a successfully integrated firm. Targeting the community, engaging the consumer, lowering costs for the consumer and increasing clinical and PBM service locations are the basis of its plan.
Typical of companies going through a merger, CVS-Aetna will look for synergies to save on costs. It will deliver better health care service through a number of transformative initiatives. This includes HealthHubs, which would drive medical efficiency and better outcomes. In the long term, CVS anticipates the business will discover cross-business and cross-functional efficiencies.
In January, CVS began its cost-reduction efforts. Although it has a $750 million cost-cutting target, management expects to exceed that. For now, inventory reduction and aggressive management of working capital are driving the cost-reduction progress, but the company will give more details in May.
Strong Fourth-Quarter Results
CVS reported adjusted earnings of $7.08 a share, above its guidance and primarily due to Aetna’s contributions to the business. Without Aetna, adjusted revenue grew 2.3% last year, which is at the top end of its full-year guidance range. The adjusted script growth of 8.8% from Retail and Long Term Care is a bright spot for the company. This is a result of successful partnering with PBMs and health plans and its pharmacy clinical programs.
Adjusted operating income fell 1.2%, as CVS decided to invest some of its realized benefits from tax reform into wages and benefits. The long-term pharmacy business is also under-performing. Despite these weak data points, retail pharmacy and scripts will grow in 2019.
CVS has a number of pillars that it expects to drive growth. First, it is growing membership by expanding its reach in the government sector, where Medicare will lead the way. At the back-end, CVS will build differentiated products and services at the community level. With 10,000 CVS pharmacies in its portfolio, its community-driven assets like MinuteClinic will go a long way in contributing to revenue and earnings growth.
CVS recently announced that it has teamed with Apple Inc. (NASDAQ:AAPL) to roll out Attain by Aetna this spring. This complements its back-end strategy of embracing predictive analytics and storing comprehensive data to better serve its customers. Structurally, its vision of creating an open-platform model will serve the needs of all payers.
CVS expected full-year adjusted EPS in 2019 will be in the range of $6.68 to $6.88, down from the $7.08 reported in 2018. Operating income will be in the range of $14.8 billion to $15.2 billion, while consolidated revenue will be $249.9 billion to $254.3 billion.
Drilling into the HCB segment, operating income will be $5.1 billion to $5.2 billion. Here, significant synergies, mostly from eliminating duplicative corporate and operational functions, will lead to savings between $300 million to $350 million. By 2020, CVS will save more than $750 million.
Valuation and Expectations
CVS is driven to improve its profit outlook in retail in three ways. First, it will grow its top line and increase script volumes. Second, it will lower its fixed and variable costs. And, third, it will migrate to the third-party peer contracting model, which incentivizes payers to reduce overall health care costs. In short, it will put pressure on core pharmacy reimbursement rates.
Should CVS deliver on its objectives this year and next, the 19 analysts who have a $79 price target on the stock will be proved right. At a recent price of $54, CVS stock has an upside of 46.6%.
Takeaway on CVS Stock
CVS is trading close to 52-week lows. Out of favor, value investors who believe the company’s merger with Aetna will pay off may want to start accumulating shares at these levels.
As of this writing, Chris Lau did not hold a position in any of the aforementioned stocks.