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CVS: Acquisition of Shares – CVS Health Corporation (NYSE: CVS)



  CVS Health Logo

Overview

CVS (CVS) appeared on my screen, which narrows the list of potential companies to invest from almost 65,000 to 68. The history of the company is quite complicated at the moment due to the transformation acquisition from Aetna, but as I have explained below, is an investment opportunity that is convincing given the reduced levels of valuation.

Note: I will often describe pro-form metrics in this article, which means that metrics have been calculated as Aetna's share of CVS for the periods shown

Selection process

I support the selection process because it eliminates personal bias from the investment process. The screen does not take into account news headlines, television heads or advice from your brother in law.

The main components of the screen are its two quantitative metrics: 1) UFCF unutilized and 2

UFCF yield is calculated as the average of the cash-free cash flows over the last five years divided by the present value of the company. In a word, this metric displays the profit (think about bond yields) that an investor would get if he bought the whole company and would put his cash flow into his pocket (think about cutting coupons).

However, unlike bonds, companies have the potential to grow, so income growth is the second part of the screen. I use the revenue increase on screen as an advantage of UFCF growth, and then I confirm the stability and growth of the UFCF in the main analysis

The diagram below shows how the display works at each stage of the process

 Image of funnel [19659012] Company Overview and Prospects </strong></h2>
<p class= CVS is one of the largest integrated healthcare companies in the US. It operates with three major business units 1) Pharmaceutical Benefits Management (PBM), 2) Retail / Long Term Care (LTC) Segment, and 3) Healthcare Segment

Although CVS is best known for its retail pharmacies, their largest division is the PBM segment whose revenue in 2018 amounted to 134 billion USD or 48% of consolidated revenue. By controlling 30% of the market share of the PBM industry, CVS is the largest in the PBM industry (source: Statista). The PBM segment mainly serves customers of employers and insurance companies and offers a wide range of solutions including pharmaceutical plan design and administration, formal management, retail pharmacy network management services, on-demand pharmacy, specialty pharmacy and infusion services, and other pharmacy-related services. . Analyst consensus forecasts predict that PBM segment will grow by ~ 3% for each of the next three years

The second largest segment of CVS by revenue is in the retail / LTC segment . 2018, or 30% consolidated pro forma income. With nearly 10,000 stores across the country, CVS is the largest retailer in the US and controls almost 25% of the market (source: Statista). Retail Retail / LTC Segments are retail pharmacies that we all know are synonymous with CVS. These retail stores generate 75 percent Its revenue from the pharmacy and 25 percent. Revenue from the "store" and others. The LTC part of this segment provides pharmaceutical services to qualified nurses, auxiliary life and other long-term care clients. The analyst's consensus predicts that the retail and / or LTC segment will grow by ~ 4% for each of the next three years

The third and newest segment of CVS is the segment of healthcare services which amounted to $ 61 billion. pro forma income in 2018, or 22% consolidated pro forma income. Approximately 38 million people in CVS are the sixth largest healthcare provider in the US and control a 3% market share (source: Statista). This segment is Aetna's business and provides a wide range of services including commercial and government medical plans, pharmaceutical services and other special services. Analyst consensus projections predict that the health care segment will grow by ~ 3% for the next three years

Consolidated analysis predicts CVS's annual revenue, EBITDA and EMU growth by ~ 4%, ~ 4%, and 6% over the next three years. Faster growth in EMU depends on operating leverage and $ 750 million. Realizing the Synergy of the Dollars

 CVS Pro Form Segment Income Source: Derived from CVS 2018 10-K and Aetna 2018 10-Q

 Historical Segment Income of CVS Source: Derived from CVS 2018 10-K, Aetna 2018 10-Q and Aetna 2017 10-K

 Pharmaceutical Industry Supply Chain

Source: Kaiser Family Fund Research Report

Acquisitions

Acquisitions

In the acquisition history, there are retail stores, healthcare IT companies, and other healthcare services. Two major acquisitions of CVS were Caremark 2007 And Aetna in 2018

The acquisition of Caremark at that time was transformed into a company that, in essence, incorporated CVS into the PBM industry (before the acquisition of Caremark, CVS created intangible revenues from its PBM business). 2006 Caremark Received $ 37 Billion US $ 1.9 billion in revenue CVS paid $ 21 billion in Caremark, ie 11.1 times higher EBITDA. This acquisition is widely regarded as the winner of CVS. 2018 The PBM segment earned $ 134 billion in revenue and $ 5.4 billion in EBITDA.

2018 November 28 CVS completed the merger with Aetna and became involved in the stratosphere of one of the largest healthcare companies in the country. . The reason for the merger was that the company transformed its customer experience to improve participation, improve health outcomes and reduce overall costs

Acquisition of Aetna transforms the company into a whole new business segment for health. products and related services. TTM for the period ending 2019 On September 30, Aetna received $ 61 billion. $ 7.3 billion in revenue CVS paid $ 78 billion (total transaction value) for Aetna, 10.7x multiplier TTM EBITDA. The purchase price was financed from $ 53 billion. US Dollars Debts ($ 45 Billion New Issued and $ 8 Billion Aetna), Cash and $ 274 Million Issue of CVS shares.

The joint venture aims to simplify the healthcare experience for the patient, better consumer participation, health improvement and lower maintenance costs

The main factor in improving customer engagement is to turn CVS into a retail store in HealthHUB where customers can get a variety of health benefits. care services. HealthHUB will be Minute Clinics, Health Studies, Nutritionists and even Respiratory Therapists to help diagnose sleep apnea people – one of the most diagnosed diseases in the US. Here's a brief overview of these HealthHUB videos from CNBC

The logic is that better customer engagement will certainly help improve healthcare outcomes, as customers are more likely to use pre-care, health-oriented services in the CVS store and health. As the overall level of CVS customer service improves due to increased engagement, overall health care costs will decrease (seeing a nutritionist and respiratory therapist is much cheaper than an emergency room visit after a cardiac arrest).

for me, but CVS will have all the hands to integrate this acquisition and move this strategy. Fortunately, the company has shown that it has been successful in the past.

Competitive Environment

The PBM industry is highly consolidated, with 88 percent of the total. The industry's market share is controlled by five top service providers (CVS, Express Scripts, OptumRx, Humana and Medimpact Healthcare Services). By controlling 30% of the market share of the PBM industry, CVS is the largest in the PBM industry (source: Statista). PBM is primarily competing for access to retail networks and price negotiations with drug companies. The scale is important because it allows PBM providers to use their volume to provide drug manufacturers with discounts. Over the last few years, the PBM industry has been under pressure to produce lower and more transparent pricing, which has reduced the profit margin. 2016 Barrono article explains industrial dynamics

The retail pharmacy industry is highly consolidated, and over 60% is controlled by five top service providers (CVS, Walgreens (WBA), Express Scripts, Optum RX and Walmart (WMT) )). With nearly 10,000 stores across the country, CVS is the largest retailer in the US and controls almost 25% of the market (source: Statista). Retail pharmacies are first and foremost competing for convenience and brand justice. The development of CVS HealthHUB aims to distinguish significantly from other retail pharmacies by providing additional services and integrated health experience, rather than just selling medicines and "store" products. Scale is important because 1) retailers can provide price reductions for PBMs and drug manufacturers, and 2) give customers consistent and integrated experience in stores and geography

The health industry is consolidated with 40% controlled five service providers (UNH), Anthem (ANTM), Humana (HUM), HealthCare Services Corp (HCSG) is Centen (CNC)). Approximately 38 million people in CVS are the sixth largest healthcare provider in the US and control a 3% market share (source: Statista). Health providers are first and foremost competing for a plan, network access and price. The scale is important because it gives healthcare providers 1) access to health care providers and 2) health care providers (ie hospitals) discounts

Possible competitive threat comes from Amazon (AMZN), which has started negotiations on the sale of pharmaceutical products through its website in 2017 at the end of the year and entered the industry with a serious acquisition of PillPack in 2018 in June. Although Amazon's threat is high in many industries, it is worth remembering that pharmaceuticals have been in the mail since the 1980s. I think Amazon is entering the space not so disturbing for the entire healthcare industry, but just as a direct competitor for other mail order companies

Another possible competitive threat is from Amazon, Berkshire Hathaway (BRK). and JP Morgan (JPM). The Joint Undertaking is called Haven and, according to a recently published website, the company is planning to "… address issues such as access to primary health care, make it easier to understand insurance benefits and make it easier to use, and prescription drugs can be purchased cheaper. " Little information on Haven's plans has been published, but health care stock prices (including CVS) were negatively affected by the news of this joint venture because they fear that Haven will ruin current revenue and profit streams. 19659038] However, there are a few things to mention, but it is about industry and specifically about CVS. In terms of industry, Amazon, Berkshire Hathaway and JP Morgan together make up 1.2 million. Households, or about 3-4 million. People. This is a fall in the bucket compared to nearly 300 million people covered by traditional health insurers. If Haven makes changes that generate revenue and profits from an existing health care system, its impact will be silenced by its small size. As for CVS, Haven mentioned that he wanted " prescription drugs to be cheaper" . Haven is likely to seek price reductions from several points in the supply chain (eg Pharmaceutical Manufacturers, Wholesalers, PBMs and Retailers). I think that the most fertile area of ​​price reductions and Haven's potential attention is to pharmaceutical manufacturers.

Pharma manufacturers (eg Pfizer) have a total profit margin of 80%. Other actors in the supply chain operate with much thinner margins (wholesalers, PBMs and retailers have 15-25% Gross Margin), so they have a lower cost.

that US prices are significantly different from other countries, leading to further price reductions for drug producers

Income growth

CVS has created impressive historical growth rates and gross revenue, and an ecological basis. CVS regularly purchases, so it is important not only to increase total revenue growth, but also to analyze the company's organic growth.

With the exception of acquisitions, the CVS grew on average by a single digit. This growth is driven by a strong healthcare industry and a solid work of the CVS management team

The following chart shows the actual results of CVS . Aetna results appear in separate rows and bands.

 CVS Annual Income Source: S&P Capital IQ; Organic Growth Calculates Obolvest

 Historical Growth of CVS in CAGR

Source: S&P Capital IQ; Obolvest values ​​green growth

Profit margin profile

CVS gross profit margin has declined over time, driven primarily by income breakdowns. The PBM segment operates at around 5 percent. Gross profit, which is well below 30 percent. Over the past 5 years, the PBM segment has more than doubled over the retail / LTC segment. The Health Benefits Segment (Aetna) generates a profit margin of around 26%, but this segment in 2019 is still in the top of the range. There are new and unaffected historical margins

CVS EBITDA margins have declined somewhat over time, driven primarily by the breakdown of revenue mentioned above. As mentioned above, the industry has had some pressure to reduce pricing, which has contributed to a small decrease in EBITDA margin in the PBM segment and retail / LTC segment. EBITDA margins in the Health Benefits Segment (Aetna) improved due to cost control and leverage.

The following chart shows the actual results of CVS and does not include Aetna.

  Historical Profit Margins for CVS Source: S&P Capital IQ

The following chart shows actual results for CVS PMB and Retail / LTC segments and actual Aetna the results of the CVS Health Benefit Segment. 19659064] CVS Historical Segment EBITDA Margins ” class=”a-c” data-width=”640″ data-height=”341″ data-og-image-twitter_small_card=”true” data-og-image-twitter_large_card=”true” data-og-image-twitter_image_post=”true” data-og-image-msn=”true” data-og-image-facebook=”true” data-og-image-google_news=”true” data-og-image-google_plus=”true” data-og-image-linkdin=”true”/> Source: S&P Capital IQ

ROIC and ROE

The historical return on investment (NASDAQ: ROIC) and return on equity (ROE) were very stable at around 10% each. Both ROIC and ROE decreased in 2018. For $ 6.1 billion USD goodwill impairment related to LTC business.

Aetna ROIC and ROE were also stable at about 10% and 15% respectively. Since CVS paid a fee for Aenta, the CVS ROIC and ROE from Aetna will decrease the premium and be below the below values, but I do not expect Aetna's supplementing CVS to significantly change ROIC and ROE.

Please note that these ROIC and ROE calculations cover all intangible assets. To illustrate a true core business, Warren Buffett always reports the results of his business units without intangible assets. The CVS ROIC and ROE would both be good north of 20% using Buffett's calculation.

The diagrams below are the actual results of CVS and are not provided in the pro-form acquisition of Aetna.

  CVS ROIC and ROE Source: S&P Capital IQ

  CVS Invested Capital Source: S&P Capital IQ

Non-Refunded Free Cash Flow

CVS has a large unapproved cash flow (UFCF) profile steady income growth, profit margin and return on capital. The company's capital expenditure over the last 5 years averaged 1.2% of revenue. Capital Expenditure is usually designed to 1) build a new store, 2) upgrade and upgrade existing stores, 3) technology modernization and other corporate initiatives

Aetna also creates strong UFCFs supported by the same drivers as CVS. Aenta's capital expenditure is minimal, averaging only 0.6% of revenue over the last 5 years

The charts below show the results of CVS pro as had Aetna ]

<img src = "https://static.seekingalpha.com/uploads/2019/3/28163143_15531134873496_rId39_thumb.jpg" alt = "CVS Unlevered Free Cash Flow  " class = "ac" Date -width = "640" data-height = "198" data-og-image-twitter_small_card = "false" data-og-image-twitter_large_card = "false" data-og-image-twitter_image_post = "false" data-og- image-msn = "false" data-og-image-facebook = "false" data-og-image-google_news = "false" data-og-image-google_plus = "false" data-og-image-linkdin = "false "/>

Source: S&P Capital IQ  Composition of CVS Unlevered Free Cash Flow

Source: S&P Capital IQ

Resistance

Evaluating Company Resistance I would like to consider 1) the company's current leverage profile and 2

An important leverage profile is important to understand the company's ability to continue its debt service if its financial performance is worse.

Although the last recession has been quite long and the companies have changed since then, after analyzing financial results for 2007-2011. There is a useful data point to see how a company can operate in the next downturn.

The balance of CVS is worrying for investors because it had $ 53bn. However, the overall debt burden is reasonable compared to the profits of both companies. 2018 December 31 The pro forma leverage ratio of CVS was 3.7 times. The management said they were about a 3.0x leverage ratio and would use the company's free cash flow to pay this debt.

As is typical of the healthcare industry, which is not as sensitive to economic cycles as other industries, the performance of CVS in the last economic downturn has been outstanding. 2010 The company slightly reduced its sales by 2.3 percent, but after that the growth was rapid. This income indicator illustrates the inflexibility of products and services offered by CVS and should provide investors with peace of mind when another downturn occurs.

The graphs below are the results of CVS pro forma […]

 CVS Credit and Resistance : S&P Capital IQ

Shareholders friendliness

CVS consistently participates in shareholder-friendly dividend payment and return initiatives.

CVS pays a consistent dividend and has increased its dividends to its shareholders. 2018 The company has paid over $ 2.0 billion. USD $ 2.00 per share. CVS increased total dividend payments and dividends by 12 percent. And 16 percent. Current dividend profitability is very attractive at 3.5%.

CVS regularly repurchased its total shareholdings and issued $ 4 billion. Dollars – 5 billion. Dollars every year from 2014 to 2017. Company in 2018

The Company will continue its dividend and suspend its share repurchase program until it reaches its target leverage in a small 3x debt to EBITDA. This is a practical step that is fiscal-conservative (to reduce leverage) and increases shareholder value (debt reduction increases equity value). I welcome this approach.

The CVS program approach to share repurchase reduces the number of shares by about 4% per year, as illustrated in the table below. 2018 The increase in the number of shares was due to the aforementioned issue of financing the acquisition of Aetna.

Owners own 1.7 million Shares of CVS shares, which amounts to 0.13 percent. Larry Merlo, Director General of CVS, owns 40 percent The value of this intrinsic property worth 40 million. Although this internal property is relatively small, executive compensation is mainly based on inventory results, which ensures excellent alignment with external shareholders. In fact, 74% p. Merlo's compensation is linked to long-term incentives. [Šaltinis: CVS SEC padavimas]

The diagrams below are the actual results of CVS and are not presented in a pro-form to obtain Aetna.

  </p>
<p class=  CVS Dividends and Repurchase

Source: S&P Capital IQ

]  History of CVS Stock Number

Source: S&P Capital IQ

  CVS CEO Pay Mix

Source: CVS SEC Filing

Company Analysis | Valuation

The price of CVS shares fell from a high of $ 112 in 2015. July. Up to the current $ 50 average. The stock price correction was almost entirely due to a decline in the company's valuation ratios. EV / EBITDA has reached 12.8x and is now 7.1 times. P / E has reached 27.6x and is now 9.8x. These current multipliers are well below the CVS long-term averages.

UFCF's yield is 8.3%, which is above the long-term average and is much better than the S&P 500 index

. calculated on a pro forma basis, assuming that Aetna was part of the CVS throughout the year. Please note that I calculate UFCF yield on average UFCF over the last five years

These valuation levels are very convincing and provide an attractive point to buy company shares

The chart below shows the actual results of CVS and not proven pro form to buy Aetna.

 Chart of Historical Evaluation of CVS

Source: S&P Capital IQ

The CVS column in the chart below is pro forma as Aetna would have been part of the CVS throughout the year. CVS 10-Yr. Avg. column is CVS & # 39; .

 CVS Comparison Grid

Source: S&P Capital IQ

Risk

Risk

Acquisition Integration

CVS is facing a difficult task of integrating Aetna, which will become the third largest business unit. In addition to integrating Aetna's activities into the core business of CVS, management also faces a general shift in strategy for the company – it is not easy for a company of this size

Mitigating Factors: CVS is not a big new acquisition integration. The company has previously acquired and successfully integrated Caremark into business. At the same time, the attractive levels of CVS assessment provide some security for integration inhibition.

Competitive Environment

CVS faces competitive pressure and customer requirements for lower drug prices, which can negatively affect its profit margin. In addition, the industry may feel confusing: 1) Amazon's mailing to drugs and 2) Amazon, Berkshire Hathaway and JP Morgan joint venture Haven.

Mitigating Factors: CVS aims to transform into a broader health care company that would increase customer engagement and increase revenue to offset the margin squeeze. In addition, at present, attractive valuation levels provide a certain margin of caution for degradation.

Ownership Right of Ownership

The management owns 0.13 percent. Unpaid CVS shares, which is less than many other companies and less than I would like. This creates an opportunity for risk taking agencies – when the company's managers have conflicting interests from the company's shareholders.

Mitigating circumstances: A large part of the executive compensation is on a reserve basis, which ensures alignment with external shareholders. Indeed, 74% of the CVS Director-General's compensation is linked to long-term incentives

Debt

CVS has recently suffered an additional EUR 53 billion. The company's current leverage ratio of 3.7x is higher than historical averages

Mitigating circumstances: CVS and Aetna generate large free cash flows, and management has announced its intention to channel this cash flow to a small 3x debt. In addition, in today's market, "3.7x" is not considered to be a major leverage effect (many private equity funds with secured funding range from 5.0 to 6.0x).

Income

Income growth: units should grow faster than GDP, around 4% per year for each of the next three years

Profit margin profile: Historically, profit margins were stable but pharmaceutical industry is under pressure to cut prices, which can lower prices.

ROIC and ROE: ROE and ROIC were stable at about 10% and should not change significantly due to acquisition of Aetna

Unlevered FCF: Strong and consistent UFCF generator; capital expenditure averaged only ~ 1% of CVS revenue and half compared to Aenta's income

Resistance: CVS balance is now more leveraged than normal, but strong cash flow generation should promptly pay off debt; The company has done a very good job in the last downturn

Shareholder friendliness: CVS pays consistent dividends and often buys shares; insider ownership is low, but compensation is linked to long-term incentives

Rating: Current valuation values ​​are lower than the company's long-term average and are very attractive

Risk: Integrate Aetna acquisition, strategy transition and potential compression of margin; however, the current assessment levels provide some security for these risks

Disclaimer

The information provided here comes from sources that are believed to be reliable, but these sources were not independently verified. Obolvest, LLC makes no representations about the accuracy of the information and is not responsible for errors or omissions. This presentation is not and nobody should be understood as an offer, invitation or recommendation to buy or sell securities.

Disclosure: I am / are a long CVS. and she expresses her opinion. I'm not getting compensation for that. I have no business relationship with any of the companies listed in this article.


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