CVS Health (NYSE:CVS) continues to struggle. Amid a merger with Omnicare and a much larger deal to acquire Aetna, CVS stock has found itself in a long-term downtrend. Now, with a federal judge scrutinizing the Aetna deal, CVS faces doubts as to whether courts will allow it to fully integrate Aetna.
Even without the legal scrutiny, the costs and challenges of the merger have put tremendous pressure on the pharmacy. However, a continuous drop in the equity’s value has resulted in a low valuation and a generous payout. Despite the company’s problems, Wall Street has likely priced in the uncertainty facing CVS Health stock.
Insurers Have Long Allied With Pharmacies
When I first heard about CVS’s intention to buy Aetna, I saw it as an interesting play. Many cite the competitive threat of Amazon (NASDAQ:AMZN) as a reason for the deal. Others might see the agreement as unusual. However, pharmacy chains and insurers have made alliances for years.
I sold Medicare prescription drug plans (PDPs) in a previous career. I knew that Humana (NYSE:HUM) offered a lower-cost plan where customers must use a pharmacy owned by Walmart (NYSE:WMT) to received preferred pricing. United Healthcare offers a similar program using Walgreens Boots (NASDAQ:WBA) pharmacies.
Interestingly, CVS and Aetna do not provide this kind of plan. In fact, the merger may have taken CVS in the opposite direction, at least for now. The company agreed to sell its Medicare Part D business to WellCare (NYSE:WCG) to gain approval for the merger.
However, owning the insurer takes these alliances to a new level beyond Medicare. It also takes CVS’s involvement in healthcare beyond medications. The deal has received criticism from members of both major political parties. Consequently, a federal judge has ordered three days of hearings in June regarding the merger, despite its closure.
CVS Stock Is Cheap but Flawed
Naturally, investors want to know where this leaves CVS Health stock. The equity trades at a forward price-to-earnings (PE) ratio of 7.5. It also pays a yearly dividend of $2 per share yielding over 3.7%.
However, I can see why our own Ian Bezek labels CVS stock a “value trap.” First, the company maintains a massive debt load. At the end of 2014, the company held around $11.7 billion in long-term debt. That increased to nearly $26.3 billion following its takeover of Omnicare. Due in large part to the acquisition of Aetna, the long-term debt had risen to over $71.4 billion by the end of 2018.
This debt fell to just under $67.9 billion as of the previous quarter. Still, that remains a heavy burden for a company with a market capitalization of almost $69.9 billion. Moreover, investors may rightly wonder what CVS bought. Analysts believe revenues will increase by 29.7%. However, they also expect profits to fall by 3.4%.
The Case for CVS stock
Consequently, CVS stock has remained in a long-term downtrend. CVS peaked at $113.58 in August of 2015. Today, it trades at around $54 per share, less than half of the 2015 peak. Moreover, the company ended its years-long streak of dividend increases in 2018.
However, while I see a lot to dislike, I also see the issues as baked into CVS stock. The average PE ratio for CVS over the previous five years comes in at around 19.7. With the myriad problems facing CVS, I do not expect it to return to that multiple any time soon.
Still, I think the PE ratio could climb to double digits. Moreover, with expected profits of $6.84 per share this fiscal year, I do not see any threats to the $2 per share dividend. Although CVS remains a highly flawed equity, CVS Health stock offers a great deal of incentive for those who want to take a chance.
Final Thoughts on CVS stock
CVS stock has become a buy despite itself. To be sure, CVS Health remains an impaired company. Questions regarding court approval and the criticism coming from both political parties bode poorly for the future success of the Aetna deal. Moreover, with the complications of managing a health insurer, I have doubts as to whether this merger will ultimately succeed. Plus, the increased debt and the end of dividend increases lessens the appeal of CVS Health stock.
However, despite the challenges of absorbing Aetna, Wall Street believes profits will continue to grow over time. As things stand now, CVS offers a 7.5-forward P/E ratio and a dividend payout of 3.7%. I do not expect great things from this company anytime soon. Still, at these multiples, CVS stock will likely move higher on any sign of improvement.
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.