Shares of pharmaceutical giant CVS (NYSE:CVS) have been in a secular downtrend for the past four years. Since peaking above $100 per share in summer 2015, CVS stock has gradually and consistently dropped amid a convergence of multiple operational headwinds, including the threat of competition from Amazon (NASDAQ:AMZN), legislative pressure to lower drug prices and a growing debt load.
Today, CVS stock trades just above $50.
To be sure, the headwinds which have dragged CVS stock lower over the past several years aren’t going away. The Amazon threat still looms large. Legislation will continue to pressure pricing throughout the whole industry. The company’s debt load has only grown with the Aetna acquisition.
But the one thing that has changed is valuation. Back in mid-2015, CVS stock was trading at a high-teens forward earnings multiple, and an unnecessary amount of optimism was priced into shares. The stock was naturally due for weakness. Today, though, CVS stock is trading at less than 8x forward earnings — the stock’s lowest valuation in the past decade — and an unnecessary amount of pessimism is priced into shares. The stock is naturally due for strength.
As such, I think now may be the time to start getting bullish on CVS stock. As with any turnaround rally, this one may take time to play out, so patience is warranted if you’re buying the dip. But the potential long-term upside is compelling, and buyers here should be rewarded in the long run.
The Story Isn’t Great for CVS Stock
To be sure, the narrative over at CVS isn’t great.
For starters, this hasn’t been a big growth company for a while, it has never been a high-margin company and it’s a very indebted company. Thus, the base from which this company is operating over the next several years is a low-growth, low-margin, high-leverage base. That’s not entirely favorable.
Further, low growth could turn into zero growth or negative growth if certain headwinds rear their ugly head. Specifically, Amazon could launch its e-pharmacy business soon, and that could rapidly steal share from CVS. Alternatively, legislation could move forward to reduce drug prices everywhere, and that could adversely impact the top line.
Also, low margins could go lower. Amazon’s entry into the retail scene killed traditional retail margins by several hundred basis points over the course of several years. A similar impact to CVS would put operating margins in the low-single-digit range.
On top of all that, the big debt load is only getting bigger. In 2017, this company only had about $20 billion in long term debt. Now, that number measures north of $70 billion, thanks to big acquisitions.
Overall, then, the story supporting CVS stock isn’t great. But, it could get better soon.
The Valuation Is Too Cheap to Ignore
The bull thesis on CVS stock is that despite the negative story, the stock is simply too cheap to ignore. That is, it’s already priced for the bad story and then some, and any upside surprise could cause a huge pop in the stock.
That upside surprise could be coming soon.
First, let’s understand how cheap CVS stock is. The trailing sales multiple is around 0.3. That’s a decade low, well below the five-year average sales multiple (0.6), and below the index average multiple (2.1). The price-to-cash-flow multiple is just above 6, which is also a decade low and well below the five year average and index average cash flow multiples. Same is true for price-to-book and forward price-to-earnings. Across the board, CVS stock is trading at dirt-cheap, decade-low valuation levels.
Second, let’s understand where the upside catalyst will come from. CVS just acquired Aetna, and with that acquisition, the company is planning on pioneering a new era of local health care. Right now, this plan lacks tangible details, but has huge upside potential if the company can properly align its experience and assets with a data-driven approach to re-imagine the way consumers look at healthcare. That’s not much of stretch, considering the company is already the king in the pharmacy world and is rolling out new HealthHUB locations, which are essentially CVS stores mixed with a digital, personalized and convenient doctor’s office.
Once this plan gets some concrete details, the narrative at CVS could turn a corner. That could happen in early June, when CVS hosts its annual Investor Day and gives investors detail regarding this new health care turnaround. Those details will improve investor sentiment against the backdrop of a really depressed valuation, and cause shares to pop in a big way.
Bottom Line on CVS Stock
CVS stock has been a secular loser for four years, but this long era of losing may come to a close in 2019 as the company gives concrete details on how it plans to use newly acquired Aetna assets to pioneer a new era of local, personalized, digital and low-cost healthcare. Those details will give the long-term bull thesis firepower, and converge on a what is today a dirt-cheap valuation.
Net result? A potentially huge rally in CVS stock through the end of 2019.
As of this writing, Luke Lango was long CVS and AMZN.