Few sectors face so much pronounced change than the broader health care industry. It’s one of the reasons why sector benchmarks like the iShares U.S. Healthcare ETF (NYSEARCA:IYH) have been so choppy lately. However, CVS Health (NYSE:CVS) has absorbed significant levels of volatility over the past few years. Since the January opener, CVS stock is down almost 14%.
And one of the biggest threats to the long-term viability of CVS Health stock is a three-word concept: pharmacy reimbursement rates. To make an incredibly long and complicated story short, this is how pharmacies get paid the bulk of their revenue.
Essentially, pharmacies receive reimbursement for the medications they provide to patients. Unfortunately for CVS stock and its ilk, the reimbursement rate has been falling for several years. And in some situations regarding generic drugs, pharmacies receive a reimbursement rate lower than the original acquisition cost.
Obviously, this has a negative impact on CVS Health stock, along with shares of rivals like Walgreens Boots Alliance (NASDAQ:WBA). If the rates don’t meaningfully improve for the industry, pharmacies risk running in the red.
And that’s really the underlining context behind CVS’s “disastrous” fourth quarter of 2018 earnings report. On paper, the results CVS posted weren’t that bad. Although management just missed its revenue target, it delivered a solid beat on per-share profitability. Against an earnings-per-share estimate of $2.04, actuals came in at $2.14.
However, the executive team revealed a lower-than-anticipated profitability outlook for this year. At the time, management stated that half of the decline will result from investments along with challenges — such as e-commerce competition — in the long-term care business. Still, a good chunk of the profitability pressure stems from reimbursement pressures.
As such, this will be a transitional year for CVS stock.
Difficult but Rational Case for CVS Stock
I wouldn’t blame anyone for not wanting to touch CVS Health stock with a 20-foot pole. Over the last four years, shares have suffered under an unrelenting bearish trend channel. Naturally, prospective buyers will want to hear more than just simple sentiment that things can’t get worse.
Clearly it can, and so far, it did.
That said, CVS stock does have a difficult but rational case for any risk-tolerant speculator. I’ll start with the most obvious bullish argument: the markets have had ample time to digest the bad news in CVS and its rivals. Although it’s not out of the realm of possibility, I don’t see shares sliding on merely reworded bearish news.
Second, the reimbursement headwind and related challenges are factors that affect everyone in the space. While an obvious statement, it levers a substantial impact on CVS stock. That’s because incoming rivals in the space such as Walmart (NYSE:WMT) are typically multi-faceted organizations. Simply, they have other concerns besides pharmacy-related obstacles.
And recent data indicates that would-be disruptors are disrupting themselves. For instance, Walmart announced that they’re eliminating pharmacy jobs as the company moves to streamline operations. To me, the optics suggest that otherwise-mighty Walmart bit off more than it can chew.
This news also reminds me about the company’s threats to leave CVS Health’s network over a pricing dispute. Walmart later retracted the aggressive rhetoric, saying the parties settled their differences. Again, the perception is that Walmart is in over its head.
By default, this provides some confidence toward CVS Health stock, where the underlying company is the expert in the field.
Insulated from E-commerce Threat
Of all the changes that have happened in retail, Amazon (NASDAQ:AMZN) is responsible for most of them. Indeed, traditional retailers have had to change their strategies to keep pace with this e-commerce juggernaut.
CVS is no different. However, what is different is that the company’s business model is naturally insulated from Amazon’s encroachment. According to the Harvard Business School, very few people buy their medication online. Thus, through simply existing, CVS Health stock has an advantage over AMZN.
It goes without saying that Amazon has aggressively beefed up its supply chain, making offers such as next-day shipping. But that probably won’t hurt CVS stock as much as you might think.
Here’s the deal: some things are simply better offline. Medicine is something I don’t mess around with. I’m sure millions more feel the same way. A comfort level exists with in-person pharmacies that the online platform will never replicate.
And e-pharmacy, if you will, is an issue with which the federal government is seriously concerned. It doesn’t take much for nefarious agents to sell prescription drugs illegally. Potentially, one bad and highly publicized incident could cripple this burgeoning industry.
However, CVS stock doesn’t face that risk. At its core, it’s a pharmacy investment. It might be boring but it works. That might be the message that finally brings shares out of the dumpster.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.
