In April 2019, with shares of CVS (NYSE:CVS) languishing around $50 on the heels of a huge early year selloff, I said on InvestorPlace that the specialty pharmacy retailer was due for a monster rally into the end of 2019, as improving fundamentals and multiple expansion would couple to spark meaningful outperformance in CVS stock.
Fast-forward 10 months and that’s exactly what happened. The CVS growth narrative only got better as we got deeper into 2019. The numbers significantly improved, investors bought the dip and the valuation multiples expanded. CVS stock roared higher, from $50 in April 2019 to $75 by the end of the year.
Now this big CVS rally is ready to extend into 2020.
Long story short, CVS is winning in the specialty pharmacy retail game. And they will continue to win throughout 2020 because the catalyst for getting their groove back in 2019 (the roll out of HealthHUB locations) will only gain momentum over the next several months. As it does, the numbers at CVS will continue to impress, analysts will hike profit estimates and the forward earnings multiple will continue to expand, because it’s still too low for its own good.
Higher forward profit estimates plus forward multiple expansion equals big share price gains.
That’s exactly what will happen to CVS stock in 2020. So don’t fade this monster rally. Stick with it.
CVS Is Winning in Pharmacy Retail
The bull thesis on CVS stock hinges on the idea that after several years of struggling to differentiate itself in the crowded pharmacy retail world, the company finally did so in 2019 and will continue to expand this differentiation throughout 2020.
Zooming out, it’s tough to tell drug stores apart. CVS, Walgreens (NASDAQ:WBA), Rite Aid (NYSE:RAD). On the surface, they all look pretty similar. In the absence of product or platform differentiation, the drug retail world has relied on price differentiation. That has led to sluggish sales and profit trends at CVS for several years.
But in 2019, CVS management found a differentiating feature — HealthHUBs, or stores that include personalized, in-store health care services like nutrition counseling and blood pressure screenings. In essence, management thought that HealthHUBs would turn CVS stores into one-stop-shop pharmacies. Because consumers love the elevated convenience of one-stop-shops, CVS management reasoned that HealthHUBs would reinvigorate traffic growth trends at the company.
They were right. According to data from foot traffic analytics platform Placer.ai, CVS stores have experienced huge spikes in foot traffic ever since the inception of HealthHUBs (while Walgreens and Rite Aid stores have struggled). That’s the good news. The better news? CVS only opened 50 HealthHUB locations in 2020. They plan to open 600 by 2020, and 1,500 by 2021.
In other words, the best of the HealthHUBs turnaround at CVS is still to come. That’s great news for CVS stock.
Shares Are Still Too Cheap
Given the promising HealthHUBs turnaround unfolding at CVS, shares of the drug retail company remain too cheap for their own good.
The forward earnings multiple on CVS stock sits at a measly 10.5. That’s below every comp you can find. The market trades at 17-times forward earnings. Consumer discretionary and consumer staples stocks both trade at more than 20-times forward earnings. The five-year-average forward earnings multiple on CVS stock is up near 13.
In other words, CVS stock is cheap relative to the market, peer stocks and its historical self.
This undervaluation won’t persist. It only happened because revenue and profit growth trends at CVS fell flat in 2017 and 2018. But in 2020 and 2021, those revenue and profit growth trends will improve.
As they do, two things will happen. First, CVS will consistently report above-consensus numbers, sparking Wall Street analysts to lift their forward profit estimates. Second, as analysts lift their forward profit estimates, investors will start to see CVS as a company with steady profit growth potential again, and the forward earnings multiple on CVS stock will expand back to its historically-normal levels.
Rising forward profit estimates plus a rising forward earnings multiple equals a rising CVS stock. It’s that simple.
Bottom Line on CVS Stock
CVS stock has been on a tear ever since April 2019 for two big reasons. One, the company’s fundamentals have dramatically improved thanks to HealthHUBs retail expansion. Two, the stock was dirt cheap and not priced for any fundamental improvement whatsoever.
Those two dynamics remain true today. The fundamentals at CVS will continue to improve in 2020 as the HealthHUBs retail expansion accelerates and CVS stock continues to trade at a huge discount to the market, peers and its historical self.
So long as those two things remain true, I say stick with the rally in CVS stock.
As of this writing, Luke Lango was long CVS.