Industry concerns persist despite CVS Health (NYSE:CVS) share price decline

Make no mistake, these are tough times for retail pharmacies across the country. Pharmaceutical giant Walgreens (NASDAQ: WBA ) has been closing stores all over the summer, and Rite Aid is all but gone here in Michigan and struggling to survive at all.

Today I want to look at one of the other big players in the industry, CVS Health (NYSE: CVS). The company has fallen in share price in recent months and despite its problems has paid a very solid dividend and trades at what would normally be described as a value P/E ratio.

I think it’s important to look deeper than the superficial issues that are well documented about the retail pharmacy industry right now and see if CVS is really a business or if we need to be more cautious about the company. faces, even at these prices.

Q2 Earnings – Full Year Outlook

Last month, CVS released its second quarter earnings release. They beat GAAP earnings estimates by 5¢ per share, while coming up about $200 million short. That in itself is not a terrible result.

The big news was that the company revised down its guidance for the full year, where instead of expecting more than $7.00 per share in earnings, it now guides to around $6.40 to $6.65. They also led to a drop in estimated operating cash flow from $10.5 billion to $9 billion.

The guidance cuts were made mainly on the basis of pressure on health care benefits.

The consolidated balance sheet

Click to enlarge

(source: most recent 10-Q from the SEC)

The thing that stands out most to me about CVS’s balance sheet is that the company has quite a lot of debt. Beyond long-term debt, the company has a current ratio of 0.86. This is not ideal with the changes the retail pharmacy industry is going through. It’s not that the company is in any way at risk of being able to pay their bills, but it seriously affects their flexibility to react to change in an effective way.

The company is currently trading at a price/book value of 0.97. That’s pretty good with a sector median of 2.41, but that alone isn’t enough for me to declare the company a value play.

risks

With the company facing so much pressure from the industry as a whole, it’s important to understand the many risks CVS faces before considering whether it’s worth considering the investment.

The company must be able to forecast health care costs and benefits. It is also increasingly important for CVS to demonstrate its ability to compete on the Public Exchange.

Retail pharmacy is a highly competitive industry, with some drug manufacturers looking to start offering direct sales to consumers. This will put pressure on CVS’s margins going forward.

The operation of a retail pharmacy is also affected by general economic conditions. The economy is doing well at this time, but a weakened economy could affect our operating results and further affect our estimated revenues and earnings in the future.

CVS has worked on consolidation and acquired a number of new partners in recent years. There is hope that there will be margin-enhancing synergies, but the company must be able to successfully integrate its acquisitions to realize those benefits.

State of Operations – Strong Profits

Click to enlarge

(source: most recent 10-K and 10-Q from the SEC)

CVS has some very good earnings for a company trading at current prices. At the same time, it’s worth pointing out that the company is experiencing a deterioration in operating margins, which is likely to continue with a recent downward trend in full-year earnings and operating cash flow.

Even with the revised down estimates, the company is expected to do quite well in the coming years. This year, they are expected to have revenue of $369 billion and earnings of $6.55 per share. Next year, revenue would be $386 billion, with earnings of $7.35 per share. That would give us a P/E ratio of 8.82 and a forward P/E of 7.86. Both are, again, well below the sector median, which in itself would make this look promising as a value stock.

Cash flow and dividend growth

Click to enlarge

(source: most recent 10-K and 10-Q from the SEC)

CVS generated quite a bit of free cash flow from operations, though it declined year-over-year, and the company revised down its operating cash flow guidance, suggesting the trend will continue.

The company also pays a pretty nice dividend, which has increased from 50¢ quarterly in 2020, to 55¢ in 2022, 60.5¢ in 2023 and 66.5¢ per quarter today. This gives us a dividend yield of 4.6%, which is very nice, and at the moment the operating cash flow suggests that this is likely to be sustainable.

At the same time, this is not an ideal dividend stock despite its growth history. CVS has declining cash flow and substantial debt, I’d say that between that and the ongoing changes facing the industry in general, any increase in dividend payouts is highly unlikely to be a priority. I’m not saying the dividend is sustainable, because I think it is, but past growth history shouldn’t be interpreted as presumptive future growth.

Conclusion

After falling to the lower end of its 52-week range, CVS looks relatively cheap today. At the same time, I feel there is too much uncertainty about the industry and the company’s future prospects to be worth taking the chance, even at these levels.

I will rate CVS as a hold currently. Going forward, I would reconsider if the company stops seeing such downward pressure on operating margins and earnings going forward. CVS has a lot of potential to make a lot of money, but only if things go well for them.