One of the benefits of a platform like InvestorPlace for our readers is the diversity of opinion on any given day, on any given stock. CVS Health (NYSE:CVS) is a good example. My colleague Will Healy feels CVS stock isn’t the bargain it appears to be.
Why? He points to the debt it piled on to buy Aetna. “Few seem to understand how much of a gamble CVS has taken by buying Aetna. CVS paid $69 billion for the insurer,” Healy wrote June 26. Now, according to him, CVS’ total debt ($74.5 billion) is 125% of its book value. It’s also 104% of the company’s market cap of $71.4 billion.
His comments are food for thought.
Me? I recently recommended CVS stock as one of seven value plays for the second half of 2019, because CVS is trading at 7 times cash flow and 8x forward earnings. Plus, I see the company’s move to deliver vertically integrated medical care for its customers as a bold effort to differentiate itself.
And yes, it might not work.
Debt is a Bad Word
So, as I ponder my support of CVS stock, Healy’s reminder about the giant debt load CEO Larry Merlo has saddled on shareholders, is top of mind. I hate investing in companies with a lot of debt — AT&T (NYSE:T) being a prime example.
I’ve long been opposed to owning AT&T stock for precisely the reason Healy warns that CVS stock isn’t so cheap. As for that InvestorPlace diversity of opinion? Here’s what Dana Blankenhorn had to say about AT&T in March.
“Assume AT&T is paying an average of 3.5% to service that debt. That’s $5.8 billion of earnings just for debt service. Now consider that it has 7.28 billion shares outstanding, and each share of T stock is getting the $2.04 dividend. That’s another $14.8 billion, a total of $20.9 billion in debt service and dividend costs,” Blankenhorn wrote.
Now, let me take a moment and use Dana’s analogy on CVS.
At the end of March, CVS had 1.3 billion shares outstanding. It currently has an annualized dividend payment of $2 a share. That’s $2.6 billion out the door. Assuming a 3.5% interest rate on its $74.5 billion in total debt, CVS is forking out another $2.6 billion in debt service for an annual expenditure of $5.2 billion.
In CVS’ Q1 2019 report, the company confirmed that its cash flow from operations would be at least $9.8 billion. In 2018, it had $2 billion in capital expenditures. Expect approximately the same in 2019. That means free cash flow will be close to $8 billion.
Right off the top, $2.6 billion will go to dividends. That leaves $5.4 billion for debt repayment and investing in its business. As a result, I believe share repurchases are off the table for the time being.
If CVS uses half that amount or $2.7 billion for the next three years, it can lower its debt by 10% over this period. However, to speed up the debt repayment, it needs to find a way to juice its cash flow beyond $10 billion annually.
That’s the tricky part.
Do I think it can be done? Absolutely, or I wouldn’t have recommended it in the first place.
Bottom Line on CVS Stock
Now for another opinion, this from InvestorPlace’s Chris Lau who recently said there’s more to CVS stock than its 3.69% yield.
He specifically highlighted the fact that the company is doing an excellent job cutting costs after the merger with Aetna. Now, if it can deliver better services to its customers, the cash flow increase I spoke of in the previous section will come to pass.
And when this happens, investors will be glad they bought CVS stock solely for the dividend, because the capital gains will be tremendous.
Until then, enjoy the $2 dividend.
At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.