Tuesday, September 06, 2011

CVS is no Rx For Your Portfolio

In August CVS Caremark (NYSE: CVS) announced that it would buy back $4 billion worth of its shares. Is this the catalyst you need to buy its shares?

Last month, CVS's second-quarter results beat analysts' estimates by a penny, This led Standard & Poor's Equity Research analyst Joseph Agnese to reiterate his Strong Buy rating on the stock. According to Barron's Agnese wrote: "With pharmacy benefit management retention rates trending in line with the prior year, we expect CVS to gain share through new business wins as it negotiates 2012 contracts."

Is this one of S&P's good calls or should you steer clear of CVS? Here are three reasons S&P might be right:
  • Decent earnings reports. CVS has been able beat analyst’s expectations fairly consistently and has done so in four of its past five earnings reports.
  • Fair valuation. CVS's price-to-earnings-to-growth ratio of 1.96 (where a PEG of 1.0 is considered fairly priced) means its stock price is not too high. It currently has a P/E of 14.3, and its earnings per share are expected to grow 14.1% to $3.17 in 2012.
Two reasons against:
  • Under-earning its cost of capital. CVS is earning less than its cost of capital – and it’s making no progress. How so? It’s producing no EVA Momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In the first half of 2011, CVS's EVA momentum was 0%, based on first six months’ annualized 2010 revenue of $95.5 billion, and EVA that fell from first six months’ 2010 annualized negative $84 million to first six months’ 2011 annualized negative $344 million, using a 7% weighted average cost of capital.
  • Increasing sales and profits -- but debt-laden balance sheet. CVS has been increasing sales and profits. Its revenue has increased at a 21.8% annual rate from $43.8 billion (2006) to $96.4 billion (2010) while its net income has increased at a 24.8% rate from $1.4 billion (2006) to $3.4 billion (2010) — yielding a slim 4% net profit margin. Its debt has grown faster than its cash. Specifically, its long term debt has risen at a 31.6% annual rate from $2.9 billion (2006) to $8.7 billion (2010) and its cash rose at a 27.4% annual rate from $531 million (2006) to $1.4 billion (2010)
CVS has used its borrowing capability to acquire -- most notably pharmacy-benefit manager, Caremark. But CVS has yet to demonstrate that it can achieve big enough efficiency boosts from the deal to justify its high capital costs. It may be that current CVS management lacks the operational expertise required to get there.

However, if CVS stock drops enough or its earnings growth is substantially higher than expected, then I'd consider buying the stock.


Post a Comment

<< Home