CVS Stock Is Cheap for a Reason

CVS Health (NYSE:CVS) continues its flirtation with multi-year lows. The slide in CVS stock continues as the company contends with increased competition. Moreover, its gamble on becoming an insurer makes the outlook of CVS Health stock uncertain.

CVS Stock

Given the current state of pharmacy retailing, CVS needed a game changer. CVS faces increased competition, as Amazon (NASDAQ:AMZN) is looking to enter the pharmacy-retailing business on a major scale. Moreover, years of high drug prices have led to increased pushback from consumers. Lower drug prices will likely not bode well for anyone in pharma. As a result, CVS’ game-changing decision to buy health insurer Aetna is understandable.

Why CVS Stock Is Cheap

However, in other ways, it appears likely that the market has a better understanding of CVS  Health stock than many in the financial media. Many, including myself, have previously argued that CVS stock is cheap, which, along with its dividend, makes it attractive.

But I increasingly see CVS stock as cheap for a reason. Few seem to understand how much of  a gamble CVS has taken by buying Aetna. CVS paid $69 billion for the insurer. That brought their combined debt from around $27 billion at the end of 2017 to more than $74.5 billion in short and long-term debt today. That places a tremendous burden on CVS, which has  a little less than $59.7 billion of stockholders’ equity.

The company also had to end its long-time practice of annual dividend increases. The current 3.73% dividend yield stands at nearly double the S&P 500 average. Nonetheless, the poor recent performance of CVS Health stock has affirmed that ending such streaks often causes years of suffering for an equity.

Merger Faces Challenges on Two Fronts

Though the deal has technically closed, investors need to remember that the agreement has not yet been fully approved by the  government. Judge Richard Leon, a U.S. District Court judge, seems intent on vetoing the agreement. However, no U.S. judge has ever reversed such a deal. Also, Judge Leon will have to contend with the Department of Justice which recommended approval of the deal.

Certainly, not everyone sees the deal as a disaster. After all, Tenet Healthcare (NYSE:THC) agreed to continue its alliance with Aetna. Nonetheless, I see the bigger worry for the owners of CVS stock is whether the deal will succeed.

In a recent article, I pointed out the success of long-term partnerships between retailers and health insurers,  such as Humana (NYSE:HUM) working with Walmart (NYSE:WMT) and United Healthcare (NYSE:UNH) allying with Walgreens Boots (NASDAQ:WBA) to offer discounted Medicare Part D pricing. However, CVS’ decision to buy an insurer takes the relationship to a new level. It also will result in CVS losing its Medicare Part D partnership with WellCare (NYSE:WCG).

CVS Stock Is an Income Play Until Proven Otherwise

Uncertainty has contributed to the downward slide of CVS stock. CVS has steadily fallen for four years. It now trades at about $53 per share, less than half of its peak of around $113 per share in 2015. The downturn has lowered its forward price-earnings ratio to just 7.4. However, traders need to remember that Walgreens trades at a forward multiple of 8.6. Another peer, Rite Aid (NYSE:RAD), is struggling to survive.

That said, investors need a reason to believe in CVS again. Despite the high dividend yield of CVS stock, the payout has not risen since 2017. Before 2017, investors benefited from annual increases in the dividend. I think resuming dividend increases could go a long way toward restoring confidence in CVS stock.

Moreover, the company could prove skeptics like me wrong and make this merger work. Still, until the company gives investors a reason to buy CVS stock, the dividend will probably serve as the largest source of profit for those who own the shares.

The Bottom Line on CVS Stock

CVS stock has and will continue to suffer from the uncertainty facing the retail pharmacy and health insurance sectors. Few understand the long road CVS Health must travel to restore confidence in the company. It has to get its merger approved. and then prove to investors that it was worthwhile.

That said, I cannot fault those who buy CVS Health stock at these levels. The forward PE of 7.4 and the 3.75% dividend yield make it at least a compelling income play. Furthermore, a resumption of annual payout hikes or proof that the merger was worthwhile could send CVS stock much higher. However, until the company can restore the Street’s confidence, CVS stock will remain an income play, at best.

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.


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