Image Source: Mike Mozart
CVS Health continues to face long-term threats to its business, and relatively weak near-term performance expectations have done little to inspire confidence. The company’s long-term debt load has exploded as it prepares to acquire Aetna, and we don’t expect the company to bounce back onto our radar given the materially increased financial leverage amidst other challenges.
By Kris Rosemann
Shares of former simulated newsletter portfolios idea CVS Health (CVS) continue to face pressure, and its first quarter 2018 report, released May 2, offered little support. Our opinion of the risks facing the company are unchanged, as threats such as Amazon (AMZN) teaming up with Berkshire Hathaway (BRK.A, BRK.B) and JP Morgan (JPM) to form a new healthcare company muddy the long-term picture for CVS. Its agreement to purchase Aetna (AET) at a time when its core business is facing material disruption becomes substantially more concerning when considering the amount of debt necessary to make the acquisition was enough for us to part ways with the idea. Read our take on the deal here, “CVS Health at the Crossroads, Too Much Debt.”
Revenue at CVS in the first quarter of 2018 grew 2.6% on a year-over-year basis thanks in part to same store prescription volume growth of 8.5%. This volume growth was driven by ongoing adoption of its Patient Care Programs, partnerships with PBMs and health plans, branded drug inflation, and inclusion in additional Medicare Part D networks in 2018 but was partially offset by continued reimbursement pressure and recent generic introductions, both of which are expected to persist at least through the near term as the healthcare industry continues to work to reduce costs of care. Front store same store sales advanced 1.6% in the quarter, but seasonal factors such as the shift of the Easter holiday and the cough and cold season supplied a meaningful boost. Soft customer traffic continues to provide a drag.
Gross profit increases in pharmacy helped push consolidated operating profit 8.5% higher in the quarter from the year-ago period, but net income advanced only 4.7% on a year-over-year basis as a significant increase in net interest expense more than offset a materially lower tax bill. CVS is already feeling the impact of a growing total debt load related to the pending Aetna deal, and it expects full-year 2018 interest expense to be $2-$2.3 billion compared to just over $1 billion in 2017. Free cash flow generation took a large step back in the quarter, falling 39% from the first quarter of 2017 to less than $1.9 billion, which was still sufficient in covering cash dividends paid in the quarter of $508 million.
CVS continues to expect 2018 adjusted consolidated operating profit growth to be between down 1.5% to up 1.5%, which was reduced in its fourth quarter 2017 report from initial guidance of growth of 1%-4%. Adjusted earnings per share guidance for the year has been issued in a range of $6.87-$7.08, up from $5.90 in 2017, and consolidated revenue growth guidance has been increased to 1.25%-3% from previous guidance of 0.7%-2.5% growth.
We don’t expect to return to highlighting CVS Health as an idea in either simulated newsletter portfolio in the foreseeable future. Meaningful long-term threats to its business remain in place, and its balance sheet will be materially deteriorated upon the closing of the Aetna deal, a feature we typically look to avoid, particularly as it relates to a healthy dividend growth profile. Lackluster near-term performance expectations only add to the negativity surrounding the company.
We currently value shares at $80 each, and the stock yields ~3.1% as of this writing to go along with a tight Dividend Cushion ratio of 1.1. We expect its Dividend Cushion ratio to be severely impacted by the meaningful increase in its net debt load once the Aetna deal closes, highlighting the long-term risks to the payout associated with a massive debt load.
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Kris Rosemann does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.