Investment Thesis
I'm not sure how many investors currently hold CVS Health Corporation (NYSE:CVS) for the growth or the dividend, but with the recent drop in share price, some may be left wondering if the dividend is secure. As an investor solely investing for dividends to supplement my retirement, this is always my main concern when my portfolio holdings have a bad quarter or year. In this article, I discuss the company's recent earnings, which caused the stock to sell off, their dividend safety, and why the healthcare giant might present a compelling buying opportunity.
Brief Overview
Before we get into the company's latest earnings and fundamentals, let's dive into their history. CVS is a health solutions company that went public in the mid-1990s. You can usually find them along with their peer Walgreens Boots Alliance, Inc. (WBA), on nearly every corner within your neighborhood. Unlike WBA, CVS made their healthcare transition earlier than their peer in 2018 with their acquisition of Aetna.
The company operates in three segments: Health Care Benefits, Health Services, and Pharmacy & Consumer Wellness; founded in 1963. Moreover, they serve more than 100 million people every day throughout the United States. Morningstar, one of the most respected investor services currently gives CVS Health a narrow moat rating.
CVS does have a long track record which gives them an advantage, especially with older consumers/patients as a result of familiarity. The company's locations & growing memberships also give them somewhat of an advantage which helps them fight off growing competition which I touch on later in the article.
What Caused The Steep Sell-Off?
Most know when a company misses on both the top and bottom lines, this usually causes a sell-off within the stock. And depending on your investment goals, this can be a great buying opportunity. Especially, if you're a long-term dividend investor looking for companies with ones that are well-covered.
CVS reported their Q1 earnings on May 1st, missing analysts' estimates on revenue & earnings by pretty sizable margins. Another reason for the steep sell-off was that management revised earnings full-year guidance from the prior $7.06 to $5.64 as a result of elevated Medicare utilization.
This is similar to another dividend growth company, Starbucks Corporation (SBUX) who recently missed earnings by a significant amount, causing management to revise their full-year guidance as well. For the first quarter, EPS of $1.31 missed estimates by $0.39 while revenue of $88.4 billion was missed by $800 million for CVS.
The Ugly
We're all familiar with the movie starring Clint Eastwood, The Good, the Bad, and the Ugly I'm sure. Well, I'm going to give you the ugly first. Aside from missing on the top & bottom lines and revising full-year earnings guidance; CVS also expects cash from operations to come in lower at $10.5 billion, down from $12 billion prior. The company has faced challenges in their Medicare Advantage business along with higher medical costs coming in $900 million above expectations.
Prior diluted EPS $7.06 $5.64 Adjusted EPS $8.30 $7.00 Cash From Operations $12.0 billion $10.5 billion
For dividend paying companies, lower cash from operations usually means lower free cash flow. And this can put the current dividend at risk. Another dividend company that expected lower free cash flow for the full-year that was eventually forced to cut the dividend was Dividend King Leggett & Platt, Incorporated (LEG), who slashed their dividend by 89%.
The current high interest rate environment has caused financial stress for many consumers since the start of rate hikes. And although this is what the tightening policy was designed to do, it has caused financial stress & hardship for several businesses, including CVS. Moreover, aside from utilization pressure, the company also faced new pressures in other categories including a cyberattack on Change Healthcare.
The Good
Despite the miss on earnings, CVS Health actually saw some positive growth in their total revenues which increased by 3.7% driven by growth in the Healthcare Benefits and Pharmacy & Consumer Wellness segments, partially offset by a decline in Health Services. Medical memberships also increased by 1.1 million on a sequential basis to 26.8 million.
Same-store pharmacy and same-store prescription sales increased 7% and 6% respectively. So, some positive for the company during a quarter that was overshadowed by a huge miss and revised guidance.
Moreover, the company now trades at a forward P/E of less than 9.9x, well below their 5-year average of 13.16x and the sector median's 26.87x. This is in comparison to Walgreens' forward P/E of 5.5x using their midpoint of guidance of $3.275. Peer The Cigna Group (CI) has a forward P/E of 12.3x using their guidance of $28.40.
CVS Health 9.9x Walgreens 5.5x The Cigna Group 12.3x
If you're a long-term investor that has been waiting on a good entry into CVS Health, then now may be your opportunity to pick up a solid dividend paying stock at a cheap valuation. The stock has already recovered some of its losses from when it dropped below $54 hitting a new 52-week low.
The Bad
With CVS revising their cash from operations to $1.5 billion lower, this puts their dividend safety under pressure. The healthcare giant has a long history of paying dividends with more than 25 years of consecutive payments. And although their dividend growth was stalled for a few years, the company recently raised it in December by a pretty sizable margin.
The quarterly dividend of $0.665 was increased by nearly double digits at 9.9% from $0.605 prior bringing the annualized dividend to $2.66. For the quarter, CVS brought in $4.9 billion in cash from operations. And although the decline in cash from operations wasn't a good thing (A drop in FCF for dividend paying companies is never something good), the dividend safety is not at risk.
However, declining cash flows are something dividend investors should be concerned with. Especially when it declines 34% year-over-year. Management attributed the drop in CFO to the timing of Medicare payments. CVS Health paid $840 million in dividends during Q1 and one way management has offset the decline in free cash flow is by buying back shares.
They recently completed a $3 billion repurchase program, retiring approximately 40 million shares. And the company doesn't plan to repurchase any additional (shares) for the remainder of this year. Using the annualized dividend and weighted average shares outstanding of 1.265 billion, the company is expected to pay out roughly $3.37 billion in dividends for the full-year. And using their projected cash from operations of $10.5 billion and CAPEX of $3 billion, CVS' dividend is still well-covered.
Risks & Valuation
One risk for the company is further downside. If the company continues to see declines in some of its segments as it did in Health Services, this could result in the healthcare giant missing analysts' estimates in the coming quarters, likely driving the share price down further.
The current macro environment will continue to play a factor as well with consumers continuing to face financial pressures due to higher for longer interest rates. But if interest rates do decline sometime this year with the majority expecting a cut in September, this could impact the company positively as rising medical costs will likely start to subside. If so, this would put the company on their path back to growth in 2025 & beyond.
Management updated their estimate for the segment which was $400 million lower than previous expectations. Furthermore, the company will continue to face stiff competition from the likes of Amazon.com, Inc. (AMZN), Walmart Inc. (WMT), and Costco Wholesale Corporation (COST), all well-known brands with strong pricing power.
However, I do think CVS Health presents a compelling opportunity at the current price of $56 at the time of writing. If you're a long-term investor I think CVS can reward you with some massive upside over the next few years.
Over the next 5 years, CVS Health's earnings are expected to grow at a rate of roughly 4.6% and at 6.68% the 5 years after that. Using the Discounted Cash Flow method I decided to be a bit more conservative with a growth rate of 4% and 3% after that. Because of CVS' higher quality and narrow moat, I think the company can achieve at least 4% growth going forward. This gives me a PT of nearly $76, slightly higher than Wall Street's price target. Of course, this is subject to change, but either way, CVS looks to be a great buying opportunity at current levels.
Bottom Line
CVS has done well with its earlier transition into the healthcare space, unlike peer Walgreens who continues to struggle. After their latest earnings report, CVS Health may present a compelling opportunity for long-term investors. Moreover, despite the decline in cash from operations year-over-year, the dividend remains secure at the moment.
As a result of the current macro environment the company will likely continue to face headwinds, but I expect management to right the ship in the coming quarters as interest rates fall sometime later this year and rising medical costs subside. CVS is a mature business with experience in tough economic environments. Although their dividend yield of 4.7% is attractive, I expect the company to get back on track later in the year/early 2025 rating them a hold for now.
The Dividend Collectuh
The Dividend Collectuh is not a registered investment professional nor financial advisor and these articles should not be taken as financial advice. This is for educational purposes only and I encourage everyone to do their own due diligence. Navy veteran who enjoys dividend investing in quality blue-chip stocks, BDC's, and REITs. He is a buy-and-hold investor who prefers quality over quantity and plans to supplement his retirement income and live off dividends in the next 5-7 years. He aspires to reach and help the hard working, lower and middle class workers build investment portfolios of high quality, dividend-paying companies. He also hope to give investors a new perspective to help them reach financial independence.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
