As we enter the final month of the year, I’d like to discuss the short- and long-term outlook for CVS Health (NYSE:CVS), the integrated pharmacy healthcare company. Year-to-date, CVS stock is up almost 15% and most of the gains have come in recent weeks.
With over a network of more than 68,000 pharmacies that serve 4.5 million customers daily, the Rhode Island-based company is currently the largest pharmacy healthcare provider in the U.S. I find CVS to be well-positioned for the country’s evolving demographics and the potential transformation of the U.S. healthcare system. Therefore, I regard CVS stock a solid long-term pick. However, there might be some short-term price weakness in the stock as investors may decide to take money off the table.
How CVS Stock’s Q3 Earnings Came
CVS n Nov. 6 reported higher-than-expected third-quarter profit. Total quarterly revenue increased 36.5% YoY.
Many of our readers will well remember that a year ago, CVS completed the acquisition of Aetna, the third-largest U.S. health insurance company by membership and revenue. In its quarterly report, management emphasized that revenue growth was primarily driven by the impact of this acquisition.
Earnings per share increased 6.4% to $1.84, 7 cents ahead of estimates. The group also raised the full-year earnings forecast to a range of $6.97-$7.05 from $6.89-$7.00.
Sales grew 36.5% to $64.81 billion vs. the expected $63.03 billion. And for the quarter, net income increased 10.0% YoY.
When CVS Health reported its Q3 earnings, investors analyzed its three main segments: Pharmacy Services (over 70% of sales come from it); Retail/LTC; Health Care Benefits (recently established).
Let’s take a look at each segment.
How CVS Makes Money
These three separate segments provide the group with diversified sources of revenue, earnings and cash flow.
The Pharmacy Services segment provides pharmacy benefit management (PBM) services to employers, health plans, and government employee groups as well as government-sponsored programs.
In November, the segment posted better-than-expected operating profit. Total quarterly revenue increased 6.4% YoY, mostly due to brand name drug price inflation as well as increased total pharmacy claims volume.
The Retail/LTC segment fulfills prescriptions for medications, provides patient care programs, sells general merchandise, and offers healthcare services through walk-in clinics. Total quarterly revenue increased 2.9% YoY.
Another way to think about this segment is the two parts to a CVS store, that is, the front retail section and the rear pharmacy section. Front-store sales represents approximately 21.5% of total Retail/LTC segment revenue.
With the acquisition of Aetna, CVS Health established a new Health Care Benefits segment, which would be the equivalent of the former Aetna Health Care segment. This segment now provides a full range of insured and self-insured medical, pharmacy, dental and behavioral health products and services.
Total revenue and operating income showed robust growth in this segment, too.
Long-Term Tailwinds for CVS Stock
Growth in Retail Pharmacy: Most consumers know CVS Health as one of the largest pharmacies in the U.S. Yet with its Aetna health insurance unit, Caremark PBM and retail pharmacies, the group has also become a vertically integrated stock, providing a wide range of services and products.
The company now operates a growing and profitable pharmacy segment, filling over a billion prescriptions per year. Going forward, CVS Health is expected to provide medical services within these store locations.
Minute Clinics: CVS currently has more than 1,100 walk-in Minute Clinics within those pharmacies, staffed by nurses and physician assistants. Minute Clinics, which started in 2000, have become the largest operator of retail health clinics, seeing patients for minor treatments, like flu shots, as well as advice on topics like weight loss and smoking cessation.
Management is also working to create “HealthHUB” pharmacies nationwide. The program is currently in pilot phase. However, the group plans to have 1,500 locations operating by the end of 2021.
In other words, there is further potential to combine CVS’ current dense local footprint with the health care benefits and services offered by Aetna.
Healthcare Industry and Demographics: We all get sick occasionally or have friends and relatives who may need treatments for chronic illnesses. Moreover, according to the Census Bureau, in about 20 years the elderly will outnumber children for the first time in U.S. history. That means the country will need more healthcare facilities and drugs. Therefore, in 2020, I expect all three segments to continue to contribute strongly to CVS Healthcare bottom line.
Short-Term Headwinds for CVS
Debt load: Despite the strength in the recent earnings results, many investors are still wondering whether CVS Health might have overpaid in the $69 billion Aetna deal. The acquisition of the health-insurance giant is adding a substantial pile of debt to CVS’s balance sheet. Therefore, potential investors may want to pay close attention to the debt levels in future earnings results.
Customer Numbers and PBM: For CVS Health, its pharmacy benefits management (PBM) services have always been very important. If CVS cannot get its current PBM customers who are insured elsewhere to switch to Aetna, then investors may get worried about future earnings and decide to step on the sidelines.
Or if CVS’s PBM business cannot achieve greater negotiating power and benefits with drug companies — as management is hoping that the merger will enable the group to do — then CVS stock may become a bitter pill to swallow.
Competitive forces: In addition, competition in the retail pharmacy business is fierce and e-commerce is changing how businesses operate and consumers shop. CVS is facing competition from other big players, such as Walgreens Boots Alliance (NYSE:WBA) and Walmart (NYSE:WMT), along with Amazon (NASDAQ:AMZN) following its acquisition of PillPack.
A potential economic slowdown or increased competition in the healthcare segment, as well as potential regulatory changes in the U.S., could cause CVS stock to underperform in the rest of the year or 2020.
Short-term Technical Charts Urge Caution
In the final quarter of the year, CVS stock’s metrics and narrative have improved substantially. And as a result, the shares have come off the lows seen in early 2019.
On Nov. 25, CVS shares hit a 2019 high of $77.03. Now, they are hovering around $75.
Because of the recent impressive jump in the stock price, its short-term technical indicators have become somewhat over-extended. Investors who pay attention to short-term oscillators should note that CVS stock has become “overbought.”
If you already own CVS, you might want to stay the course and hold onto your position.
Or you may also consider opening a covered call position in conjunction with going long on CVS shares.
In general, selling covered calls on dividend-paying stocks, like CVS, would enable long-term investors to weather further volatility as well as create extra portfolio yield. Long-term shareholders currently enjoy a current dividend yield of 2.6%. If you would like to find more about the strategy you may want to talk to your investment advisor or broker.
The internet also offers plenty of examples of how to execute covered calls. Most investment advisors would regard a covered call as a conservative strategy that requires no extra margin.
Bottom Line on CVS Stock
Long-term, I am quite bullish on the outlook for CVS stock as I believe management will take the right steps to achieve acquisition synergies. Now, the group has a wider reach in the healthcare industry.
Furthermore, as its debt levels decline, interest expenses will also decrease. As a result, CVS stock’s earnings are likely to get on the road to a steady growth trajectory. Indeed, Q3 earnings released in early November show across-the-board sales growth.
However, in the coming weeks, I’m expecting some profit-taking in CVS shares. Such a potential drop in the stock price would give long-term investors a better entry point in 2020.
As of this writing, the author did not hold a position in any of the aforementioned securities.