Weekly Equity Idea Highlight - 2019 09 18
After CVS's stock sell-off in late 2018 to early 2019, current market expectations for CVS are excessively pessimistic. Markets expect UAFRS-based (Uniform) ROA (ROA') to roll over to prior lows from 2010-2011. However, the company's fundamental strategy is likely to lead to continued ROA' expansion. CVS has been evolving into a full-service healthcare firm since their acquisition of Caremark in 2007, which led to initial ROA' expansion to 15%-17% levels. This was followed by continued investment in healthcare solutions and monetizing their data on customers leading to an ROA' plateau shift the past 3 years, to 19%+ levels. With the new acquisition of Aetna to add to this structure, the company is now positioned to recreate the exact fundamental framework that UnitedHealthcare has created over the past 5+ years that has led to a 1,500bps+ expansion in ROA. With the market not giving the company credit for this strategy, there appears to be opportunities for significant equity upside.Management's alignment and confidence in recent calls point to reasons to believe in further operational improvement. Management is specifically compensated to focus on RONA and EBITDA expansion, meaning they will be driving ROA' expansion while growing, not seeing declines, as is currently expected. Also, management consistently has shown a lack of concern about hitting on synergy targets or executing on the Aetna acquisition the last several quarters.
Considering low market expectations, in terms of pessimism for both growth and Uniform ROA recovery, positive tailwinds and management's alignment and strategy, and lack of concern about executing on their strategy for the business, current low equity valuations appear unreasonable, spelling potential for equity upside.
CVS Health is a health company. The company's segments are: Pharmacy Services, which provides a range of pharmacy benefit management solutions, including plan design offerings and administration, formulary management, and retail pharmacy network management services; Retail/Long-Term Care (LTC), which sells prescription drugs and general merchandise, including over-the-counter drugs, provides health care services through its MinuteClinic? walk-in medical clinics and conducts LTC pharmacy operations; and Health Care Benefits, which provides a range of voluntary and consumer-directed health insurance products and related services, including medical, pharmacy, dental and behavioral health plans.
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