The broader health care sector hasn’t done very well in 2019 either. The Health Care Select Sector SPDR Fund (NYSEARCA:XLV), which counts CVS stock as one of its largest components, is the worst performer among nine sector ETFs year-to-date.
Click to EnlargeThe $70 billion deal still faces some challenges in court, but if it goes through, it would create a vertically integrated health care giant. CVS would be a pharmacy, a pharmacy benefit manager (CVS Caremark), a health insurer, and a primary care provider (through its MinuteClinics).
This could potentially shake up America’s health care system.
CVS beat analyst forecasts when it reported first-quarter earnings on May 1, sending CVS stock up higher to the mid-50s, although it has lost ground since then.
Is it time to buy CVS stock?
Bulls would say “yes” emphatically. Although the health care sector is not doing so well this year, it is projected to grow faster in the years ahead. Also, CVS is a low-beta stock — 1.09 at yesterday’s close — and it trades at low valuations, and the stock might benefit from the merger with Aetna. It also pays a nice 3.82% dividend.
Bears, on the other hand, would not buy CVS stock. They would cite political risks from both sides of the aisle, the opioid crisis, and competition from Amazon (NASDAQ:AMZN) entering the health care sector, both with its PillPack acquisition and its Haven disruptor venture. They also would warn investors about the company’s high debt levels.
Let’s take a look at both sides of the story.
CVS Stock Pros
Growing Sector: The health care sector is growing faster than the rest of the economy, and this could benefit CVS stock.
According to projections from the Center for Medicare and Medicaid Services, U.S. spending on health care will grow at a 5.5% annual rate from 2018 to 2027. By 2027, the U.S. will be spending $6 trillion a year on health care, up from $3.65 trillion in 2018.
Part of this is due to factors such as America’s growing aged population (along with most of the developed world).
Growth in the health care sector could be a tailwind for CVS stock.
Low Beta: As a relatively low-beta stock, CVS is unlikely to be hit hard by cyclical economic downturns.
People will always need medicine and household essentials sold at CVS. During a downturn, you might put off buying a new car or going to a casino; you aren’t going to buy less toothpaste and toilet paper.
If you think this bull market has gone on long enough and a downturn is around the corner, it might make sense to look at stocks like CVS.
Valuation: “Across the board, CVS stock is trading at dirt-cheap, decade-low valuation levels,” InvestorPlace contributor Luke Lango concluded in April.
Lango looked at several valuation metrics. Many of his observations are still true.
“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.”
CVS Stock Cons
U.S. Politics: Washington’s wrangling could also pose a problem for health care companies like CVS. This has already hit CVS stock.
The Democrats are moving toward greater intervention in the economy, with an emphasis on the health care sector, which accounted for 17.9% of U.S. GDP in 2016. Several Democrats running for president in 2020 have endorsed “Medicare for All”, which could eliminate private health insurance.
CVS just bought a health insurance company, Aetna, for $70 billion.
Amazon: Amazon has already disrupted multiple industries, and health care could be next.
Last year, Amazon formed health care company Haven with JPMorgan Chase (NYSE:JPM) and Berkshire Hathaway (NYSE:BRK.B). This joint venture will be free from profit-making incentives and constraints; its goal is to improve health care while lowering costs. There’s also the aforementioned PillPack, an online pharmacy startup.
Opioid Liability: CVS stock could also suffer if the company is hit with more opioid lawsuits.
I mentioned the opioid crisis last year in an article on Johnson and Johnson stock. Thousands of people in the U.S. have died as a result of overdosing on opioids such as hydrocodone and fentanyl.
While the federal government is working to combat this opioid crisis, CVS faces opioid lawsuits from the Cherokee nation, City of New York, and the state of Florida. If more jurisdictions file lawsuits against CVS, the stock will be negatively impacted.
The Verdict on CVS Stock
In my view, the cons outweigh the pros and I would stay away from CVS stock for now.
Yes, CVS stock is cheap, but sometimes stocks are cheap for a reason. Cheap stocks can sometimes be value traps, and InvestorPlace contributor Ian Bezek thinks CVS is a value trap right now.
I’m inclined to agree. I think the Amazon threat is real.
Some may argue that Amazon’s success as a pharmacy is not guaranteed. Indeed, Amazon invested in Drugstore.com in 1999 only to see the site sold to Walgreens Boots Alliance (NASDAQ:WBA), which shut it down in 2016.
However, Amazon was a much smaller company back then. Today it is an $800-billion behemoth.
The technology research firm CB Insights recently detailed Amazon’s ambitions in the health care sector.
Can CVS out-innovate Amazon? I’m not so sure.
I would hold off on buying CVS stock.
As of writing, Lucas Hahn did not hold a position in any of the aforementioned securities.