April 20, 2021 - 4:37pm EST by
2021 2022
Price: 76.00 EPS 0 0
Shares Out. (in M): 1,311 P/E 0 0
Market Cap (in $M): 99,663 P/FCF 0 0
Net Debt (in $M): 53,793 EBIT 0 0
TEV (in $M): 153,456 TEV/EBIT 0 0

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CVS provides health care service through Retail, PBM and Managed care channels. It was founded in 1963 as a convenience store and later retail pharmacy, but over the last 15yrs acquired assets including Caremark PBM (2006), Omnicare LTC pharmacy (2015) and most recently Aetna managed care (2018). As of FY20, profits are roughly evenly split between the 3 divisions. CVS seeks to be the most consumer friendly health provider, offering service in store pharmacies, clinics or via mobile phone.



Our view

What’s it worth

  • Risk from Amazon entering PBM and persistent retail headwind

  • Higher than ideal leverage

  • Unproven in-store primary care model

  • Moat enhanced with Aetna acquisition, rebate clarity enhanced in PBM; AMZN threat is valid, but have had tough time making health care progress

  • New CEO Karen Lynch (from Aetna) brings potential as first non-pharmacist health care exec running business since its founding

  • PBM risk as % of profit reduced with Aetna deal

  • $100-120 on DCF with 4% rev growth and modestly lower margins

  • 13% current FCF yield very modest for such an established, growing business


Revenue progression

EBIT mix



After spending years assembling a comprehensive offering to enhance its legacy retail pharmacy, CVS is now a unique health care company, with balanced profit between its Retail, PBM and managed care businesses. This is a lower risk and higher quality offering than either a retail or retail/PBM model, yet CVS trades at or below its historical average multiples and peer group. As the market begins to appreciate CVS’ evolution, shares are likely to re-rate upwards from current <11x EV/EBIT. Even if they do not, 13%+ FCF yield should benefit equity as the company pays down debt. There are multiple ways to win. CVS is also likely a solid defensive holding in the event of market downturn. Current price, with modest margin declines, implies -2.9% revenue CAGR, a stark contrast to persistently growing health cost trends. This suggests fears such as Amazon disruption are reflected in price. If CVS can execute on its strategy, competitors will be challenged to match its offering and investors should be rewarded. Bullish investors may consider some of the available LEAPs to express this position.

Why now?

Aetna integration well underway. CVS acquired Aetna in 2018. While the merger has thus far been mostly about cost synergies, 2021 is the first year Aetna members will be offered a plan that leverages CVS’ retail infrastructure. Aetna Connected will offer no-copay visits at MinuteClinics and HealthHUBs while also coordinating with primary care, offering in-store health discounts and PBM benefits. If market reception for plans leveraging CVS physical network is positive, it will be a new source of competitive advantage and future profitable growth.  

Amazon showed some of their cards. After years of speculation, and 2yrs after acquiring Pillpack for $750m, Amazon launched its pharmacy in November 2020. Offerings include discounts for uninsured drugs (minimal impact to CVS), free 2-day delivery (CVS offers better terms), discounts on drugs (for relatively small uninsured population). In sum, none of this should dramatically impact CVS. There is always a risk that this is a first step towards a more disruptive entry into health care, but CVS seems to have the highest barriers to entry among peers while trading among the lowest multiples.

PBM appears to be recovering. After a tumultuous couple of years, where the method of PBM reimbursement became headline news, CVS has adapted to reduce pharma rebates’ impact on its bottom line. The rearranging of profit streams negatively impacted 2018-20 profitability, but is now minimal. After weakness in PBM customer adds, the segment appears to be recovering.


Business model

CVS business lines interact with each other, offering many advantages as depicted below. Each is a decent business standalone, but the integrated offering has potential to create a better solution for managing health outcomes and costs.

Thus far, the PBM/retail benefits are proven as Caremark members benefited from the flexibility of a hybrid retail/mail model. The advantages of PBM/managed care are likely to be realized, as the other large PBMs have been acquired by managed care (UNH/ CI), validating the odds of success at CVS. Retail has not yet proven its value in terms of MinuteClinic/HealthHUB (“primary care lite”). Current valuation does not imply success, but if the integrated business model proves superior, upside to CVS equity is meaningful.


Amazon headlines. Even though nothing unveiled thus far appears to impair CVS, any time Amazon releases a healthcare-related press release, CVS tends to trade down. This is a risk investors have to deal with, until the market eventually gets comfortable that CVS can thrive in a health care market that Amazon participates in.

MinuteClinic / HealthHUBs model not transformative. CVS has made a large strategic bet that in-store clinics will help it manage costs of chronic care patients. This has not materialized under MinuteClinic, so management doubled down with HealthHUBs, which are more comprehensive MinuteClinics offering “80% of the capability” of a primary care physician. The financial investment is a modest near term capex increase. At this point, the HealthHUB risk is limited, as investors ascribe little value to its potential. If CVS demonstrates the ability to drive better outcomes at lower cost, it deserves a much higher multiple, as this capability would be enormously valuable to the health care system and difficult to replicate.

Rebate risk/headlines. Rebates had been a major area of investor concern, as CVS is paid a rebate by drug manufacturers for meeting certain targets such as market share. While CVS claimed to pass >90% of rebates back to customers, the exact nature of rebates is confidential, so there was fear that CVS was over-earning from a profit stream that may go away with increased scrutiny. It has since adjusted PBM design to reduce rebates, and this headwind has largely passed, as of 2021, as the quotes below show: 

While some have speculated that our retained rebates represent as much as $2 billion, the simple fact is that over the last number of years, we have positioned the Caremark model and its broader value proposition to the point where in 2018 we expect retained rebates to be about $300 million, or about 3% of our annual adjusted EPS.”. Q2 18 earnings, 8/8/18


“As you look at the transitory nature of the headwinds, you think about the impact of the investments in tax reform that rolls off mid-year of this year. You look at the inflation impact on our rebate guarantees that peaks in 2019 and rolls off at the end of 2020.” Q4 18 earnings; 2/20/19


“What we guided was that the rebate exposure would peak in 2019, and then that will begin to dissipate over the ensuing year. So we expect that exposure to get less in 2020 and 2021. And so far this year, it's pretty much well within our expectations that we laid out within our guidance.” Q1 19 earnings; 5/1/19.


The financial impact of ensuring more rebates were passed back to customers has passed, and has faded as an investor concern, as shown by counting “rebate” mentions in recent calls:

Government intervention. Unlikely, but investors concerned about single payer health care in the US should avoid the industry entirely.


Not very exciting. Annual bonus is mostly based on EBIT targets. Long-term award is mostly based on EPS, with adjustments for leverage reduction and equity return targets. Overall compensation is very generous. It does not really move the needle financially, but would like to see more downside risk to executives for middling performance. This is also true of the Board, consisting of 12 non-executives all aged 63+, paid >$300k each. 


Covid boost. Between COVID tests and vaccinations, 8m new customers engaged with CVS during the pandemic. These people provided their information digitally, so there is an opportunity to win a portion as long-term customers. 8m is a decent number relative to the 72m who had given CVS permission to text them as of FY19.

ACA marketplace re-entry. With the individual market stabilized, CVS has plans to re-enter in 2022. If it can profitably add members using its clinic footprint, it would drive earnings and sentiment.

Diverse management team. CVS is one of the most diverse leadership teams in corporate America. Its CEO, CFO and Retail president are female. While no one will care if they do not deliver results, if execution begins to improve this could further enhance sentiment. 


Trades at discount to peers, despite seemingly superior strategic position to many.

By any metric, CVS appears cheap. It has a low-teens FCF yield, >2.5% dividend yield. Underlying 4%+ revenue growth and stable operating margins should merit at least historical trading multiples. If the integrated model proves superior, multiple expansion is likely.


Historical revenue & profitability

Historical trading multiples

Additionally, reverse DCF implies MSD declining revenue at stable margins. Given inherent health care inflation, CVS decent execution and formidable assets to fend off competition, this appears overly bearish. In the above scenario, a $95+ share price seems very plausible. 


Investors who believe in CVS potential and the impact of near term headwinds rolling off may also use LEAPs, which are reasonably liquid, expiring Jan23.



Overall, CVS risks seem priced into share price and potential benefits of the integrated model coming together are underappreciated. This cash flow generating defensible business could also be a good portfolio addition if the market becomes less bullish.


I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


Data points on integrated Aetna/CVS plans

PBM recovery continues

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