Last October I wrote about the just-leaked CVS Health (CVS) bid for health insurance giant Aetna (AET) and tried to convey the notion that the move was about far more than just diversifying away from retail pharmacies for fear Amazon might compress margins in that industry. Interestingly, CVS’s stock price was $69.05 when I published that note, and today it closed at $69.05. So almost 10 months later and all investors have earned from the shares is the not-too-shabby 3% annual dividend.
CVS reported a solid second quarter this week and is on pace to book nearly $7 of free cash flow per share in 2018 ($6.88 in my internal model), which puts the stock at 10 times free cash flow, a price normally reserved for melting ice cube businesses. And there are plenty of people who see CVS (incorrectly) as just a bricks and mortar pharmacy company destined to be disrupted by some trillion dollar market value tech darling. Others acknowledge their huge pharmacy benefits management business (Caremark), but believe the thesis that those firms are actually robbing their commercial clients blind and helping boost drug prices, when the opposite is actually true (and hence why their clients don’t fire them). If both of those notions turn out to be correct, CVS will not be a good investment over the next 5 or 10 years, but I am taking the opposite view.
In fact, the story will get even better when the Aetna deal closes (CVS management indicated on their quarterly conference call this week that September or October is the most likely timeframe for closure). Essentially, CVS is building a healthcare services juggernaut, it seems to me anyway, and will be able to use a vertically integrated business model to offer consumers numerous options and generate efficiencies in an otherwise complex healthcare system. Bears on the company seem to fail to realize that a network of drugstores and in-store clinics, coupled with pharmacy plan management, assisting living and nursing home drug distribution, and insurance plans is an all-encompassing system that can be designed and integrated in such a way as to drive convenient usage from customers of all shapes and sizes, which in turn should bring down costs as scale is leveraged.
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