The right play on the health of CVS (NYSE:CVS)

Shares of the healthcare solutions giant CVS Health Foundation (New York Stock Exchange: CVS) They are down about 25% since April 1, 2024, as a poor 1Q2024 report and downwardly revised forecasts for FY24 weighed on that. The company is seeing a higher than expected medical benefit rate in its Medicare Advantage plans, while it is not eligible for full-level quality bonuses in FY24 because there are fewer 4-star plans. With 87% of its members expected to return to 4+ star plans (setting up a stronger fiscal ’25) and a safe dividend yield of 4.4% versus net leverage of 4.1, CVS was once again worth a deeper dive. The analysis follows below.

CVS Health Corporation is a healthcare solutions provider headquartered in Woonsocket, Rhode Island with more than 9,000 retail locations, 1,100 walk-in clinics and 205 primary care clinics. He is also a pharmacy benefits manager with nearly 90 million plan members and health insurance providers Supplier to approximately 36 million Americans. With FY23 revenue of $357.8 billion, CVS has the 10th highest revenue globally.

Founded in 1963 as a consumer value retailer, the company was purchased by Melville Corporation in 1969, and was essentially spun off when Melville completed its last divestiture (of footwear retailer Footstar) in 1996 with its first trading as an independent entity in which At $9.56 per year. stock, after activating a 2-for-1 stock split.

CVS stock is trading at around $60.00 per share now, which translates to an approximate market cap of $76 billion. In early 2023, CVS complete Purchasing medical center operator Oak Street Health as part of its efforts to become a more comprehensive, vertically integrated concern. In hindsight, it appears that CVS overpaid for this acquisition.

Reporting segments

With the aforementioned acquisition of Oak Street Health (plus Signify Health) in 2023, the company realigned the composition of its operating segments, renaming two of the four segments from which it assesses its performance. The units are now Health Care Benefits (HCB); Health services (formerly pharmacy services); Pharmacy & Consumer Wellness (PCW) (formerly Retail/LTC); And companies.

HCB came about thanks to CVS’s acquisition of Aetna Health in 2018 and includes employer and government health plans with a provider network of about 1.7 million health care professionals. The sector derives approximately three-quarters of its top line from contracts with the Centers for Medicare and Medicaid Services (CMS) and another 14% from the federal government. Adjusted HCB generated FY23. Operating income of $5.58 billion on revenue (primarily premiums) of $105.6 billion versus adjusted FY22. Operating income was $6.34 billion, versus revenue of $91.4 billion, down 12% and 16%, respectively. The bottom line decline was due to increased utilization in Medicare Advantage, where the overall medical benefits ratio (MBR) increased from 83.8% in FY22 to 86.2% in FY23.

Health Services includes the full gambit of pharmacy benefit management (PBM) solutions under the CVS Caremark umbrella, including offerings of plan design and management, formulary management, retail pharmacy network management (60% of total segment revenue), and mail order pharmacy (36% ). ). This unit maintains a national network of approximately 66,000 retail pharmacies and was responsible for filling or managing 2.3 billion prescriptions on a 30-day equivalent basis in FY23. It competes with large independent PBMs such as Prime Therapeutics and MedImpact, as well as proprietary companies By health plans such as Cigna (CI) Rapid Scripts and OptumRx from UnitedHealth. It also now includes more than 1,000 MinuteClinic mobile clinics, Oak Street’s value-based care services, and Signify’s home assessments. Health Services represents fiscal year 23 Adj. Operating income of $7.31 billion on revenue of $186.8 billion vs. Fiscal 2022 Adj. Operating income was $6.78 billion on revenue of $169.6 billion, up 8% and 10%, respectively.

In addition to creating a more vertically integrated model, the reason for bringing Oak Street on board was to improve CVS Medicare Advantage’s star rating, which fell sharply from 78% with four-plus stars in FY23 to just 21% in FY24. The rating program is under the Affordable Care Act and is designed to encourage competition based on quality. Plans with four or more stars receive a 5% quality bonus and the ability to bid against a higher benchmark rate.

Due to the pandemic provisions being phased out in 2023, a decline in the industry’s star ratings was expected, but CVS was particularly sharp. However, the percentage of Aetna Medicare Advantage members in 4+ star plans is expected to return to 87% in 2025, which would save approximately $700 million in FY25.

PCW consists of approximately 9,400 retail locations — 85% of Americans live within 10 miles of a CVS — and online retail pharmacies, which sell prescription drugs and general health and wellness-related merchandise. This unit dispensed 27% of total U.S. retail pharmacy prescriptions during 2023 and provides approximately 75% of the segment’s revenue. The retail pharmacy sub-unit competes for business with Walgreens (WBA), Rite Aid (OTC:RADCQ), Walmart (WMT)And Amazon (AMZN). PCW Established FY23. Operating Income of $5.96B on Revenue of $116.8B vs. FY22 Adj. Operating income was $6.53 billion on revenue of $108.6 billion, representing a decrease of 9% and an increase of 8%, respectively. The bottom line was a result of continued pharmacy reimbursement pressure, offsetting a 13.6% increase in same-store pharmacy sales.

Putting all of that together with $51.9 billion in corporate overhead and cross-segment omissions – primarily when some pharmacy service customers (maintenance opt-in) choose to pick up prescriptions at a retail pharmacy rather than by mail, resulting in double counting – CVS generated FY23 adjusted operating income of $17.53 billion and EPS of $8.74 (non-GAAP) on revenue of $357.8 billion versus adjusted FY22 operating income of $18.04 billion and EPS of 9.03. USD (non-GAAP) revenue of $322.5 billion, representing a 3% decrease in bottom-line profitability metrics and an 11% improvement in top-line profitability. It also achieved cash flow from operations of $13.4 billion, down 17% from $16.2 billion in FY22.

Q1FY24 and FY24 forecasts

Heading into FY24, CVS produced a quarterly blowout when it reported financials on May 1, 2024, reporting 1Q24 earnings of $1.31 per share (non-GAAP) on revenue of $88.4 billion versus $2.20 per share (non-GAAP) on revenue of $85.3 billion, reflecting a decline of 40% and an increase of 4%, respectively. Cash flow from operations also declined significantly, from $7.4 billion in the first quarter of 2023 to $4.9 billion in the first quarter of 2024, due to the timing of Medicare payments. Although The Street expected a hit due to the unfavorable impact of the company’s 2024 Medicare Advantage Star ratings, it did not expect MBR to rise from 84.6% to 90.4% year over year. Health Services also lost a “major client,” sending revenues down 10% year over year to $40.2 billion. Because of these factors, CVS’s bottom line beat consensus by $0.39, a major setback for a typically stable business model.

Furthermore, in a change of course, management expects its headline rate to remain elevated throughout the budget year (89.8% vs. previous forecast of 87.7%), forcing it to revise its non-GAAP full-year earnings estimate from $8.30 at least. The stock has a price of at least $7.00 per share and has cash flow from operations expectations of at least $12.0 billion to at least $10.5 billion. In the long term, management remains confident in its ability to return to a 4% to 5% net profit margin. For reference, the new FY24 earnings forecast calls for a net margin of 2.3%.

Not surprisingly, the market reacted sharply, sending CVS shares down 19% in the subsequent trading session, marking their worst single-day performance in more than a decade. In addition to the disappointing 2025 final price notice news from CMS for Medicare Advantage a month ago, the company’s stock has lost nearly 25% of its value since April Fool’s Day, even with the stock’s recent rally over the past two weeks or so. .

Balance sheet and analyst comments:

despite of “At least $10.5 billion“Although it’s down 35% (at most) from $16.2 billion in FY22, it’s still enough to cover its $0.67 quarterly dividend (from $3.36 billion in annual payments), for a current yield of 4.8%. CVS completed a $3 billion buyback authorization in the first quarter of 2024, repurchasing 39.7 million shares and based on the performance of its stock since then, it looks as if management should have kept some of its stock dry and is not planning to buy back any shares Additional in 2024. The company held cash and investments of $37.2 billion versus debt of $64.1 billion at March 31, 2024. As $24.1 billion of cash and investments is long-term, the company’s net leverage is increasingly represented in relation to 4.1.

The Q1 2024 report and downwardly revised FY24 forecasts caused three analyst firms (Leerink, HSBC and UBS) to jump ship and downgrade the stock to hold. The company’s analyst community is generally roughly split between maintaining buy or hold ratings on the stock. On average, they are Expect CVS will earn $7.03 per share (non-GAAP) on revenue of $368.8 billion in FY24, followed by $7.85 per share (non-GAAP) on revenue of $387 billion in FY25. Final estimates are well below $9.00 and $10.00 per share (non-GAAP) in spring 2023.

Verdict:

Although Medicare Advantage utilization trends are difficult to predict, the credibility of management’s forecasts should be affected by the somewhat radical revisions to its FY24 outlook after just one quarter in the books. However, if Street analysts are to be believed – who were also wrong – CVS stock is trading at an 8.6 P/E for FY24E and nearly seven times the lower end of its FY24E operating cash flow forecast.

Factor in a safe 4.4% yield and factor the bleak FY24 outlook into its price, look for CVS Health Corporation stock to fall into a range of roughly $55 to $65 per share. This makes the stock solid Covered call candidate, but there’s not much other than fairly tepid earnings retention.

NB: CVS was recommended exclusively to members of our investment group as a covered call trade one month ago when the stock was trading just above $55 per share (roughly the bottom of what we believe will be the stock’s new range in the medium term).