CVS Health: Lookback, Management Guidance Vs. Results 2018-To-Date

For the last several years, I’ve been constructive on CVS Health Corporation (NYSE:CVS). In my most recent article, published on November 28, 2023, I encouraged investors to “play the long” game.

A Brief History Lesson

No later than 2016, ex-CEO Larry Merlo recognized the corner drug store business wasn’t going to age well. So, he set strategy for CVS to become a verticalized health care company. His parting shot was the $69 billion Aetna acquisition. That deal closed in late November 2018.

His assessment was correct. Given the benefit of hindsight, the stand-alone pharmacy store business turned out to be a nearly unsustainable business model.

For nearly a decade, peer Walgreens Boots Alliance (WBA) stock has registered a nearly continuous decline, peaking at ~$85 in the summer of 2015 and recently settling at $19.

Weak sister Rite Aid (OTC:RADCQ) imploded, and the shares now reside in the C11 penny-stock discard bin.

Recently, Walgreens purchased / taken over a number of the old Rite Aid stores.

Notably, other U.S. large pharmacy outlets are diversified retailers like including Walmart (WMT), Kroger (KR); or integrated health care organizations like Cigna (CI) and UnitedHealth Group (UNH).

Back at CVS, on February 1, 2020, during the C19 pandemic, legacy Aetna CEO Karen Lynch took over the CVS Health business. Today, she is one of the most powerful women in American business.

Ms. Lynch and her staff steered the company through the pandemic, integrated Aetna, built up the business, and deleveraged the balance sheet.

Nonetheless, on balance, the stock has not responded.

Since the beginning of 2019, CVS common shares provided ~5% total annualized return versus returns of 11% and 16% for the Health Care Select Sector SPDR (XLV) and the S&P 500 (SPY), respectively.

If one accumulated CVS Health shares during the 2019-2020 troughs and include the dividends, it’s not a terrible performance, but the stock’s been a laggard.

What’s The Problem?

I believe part of the lack of performance has been CVS’ ongoing acquisition mode. Almost as soon as the Aetna merger integrated and associated debt leverage brought down, management embarked upon another twin set of purchases.

In early 2023, the prizes were the $18 billion Signify Health and Oak Street Health transactions. The acquisitions made for good strategy: CVS’ profile became an up-and-down individual health solutions provider.

• Pharmacy and PBM

• Insurance and health benefits

• Consumer Wellness, including access to doctors, nurses, and skilled medical staff

The Street promptly threw up all over it.

The stock fell from about $100 to $70. CVS stock sits ~$75 today. There’s solace in the fact the 3.6 percent dividend yield is generous and safe. Nonetheless, I do not expect the dividend to rocket upwards.

In my opinion, there’s nothing wrong with the overarching strategy nor the execution thereof. CVS’ fundamentals remain sound. However, the recent acquisitions snowplowed better margins, cash flow, and profits another year or two into the future.

Back in 2019, I expect 2023 to be the breakout year. Now, I suspect we’re looking at 2025 or 2026.

Has Management Delivered?

As an investor, this is often an interesting question. If the answer relies strictly upon stock performance, then the answer is clearly, “No.” However, to be fair, management can influence stock prices but hardly has control.

So, I thought to look at this question from another angle: over the long-term has management met or exceeded their guidance?

Three points need to be made.

First, I like to see it when a management team provides clear, unambiguous financial guidance. In the case of CVS, senior leadership routinely provides some of the best and most detailed guidance I’ve seen.

Second, I tend to focus more upon management guidance versus Street forecasts. Indeed, while I review and utilize Street consensus forecasts, this reflects an outside-in view and may include brokerage bias. I contend management guidance is a better yardstick: I see it as a “promise” that needs to be met, or there’s got to be some real good reasons why it was unachievable.

Third, while management has limited control over stock prices, they have a great deal of control over what guidance is presented to investors and their ability to execute upon stated financial objectives.

Unquestionably, some management teams provide forward guidance and make it, year-in and year-out.

Others, not so much.

Let’s Look CVS’ guidance For the Last 7 Years

The punch line of this article is part of the continued “long game” thesis: since 2018, how has management fared when comparing their early-year guidance versus the actual results?

Yes, there’s been a lot of changes going on at CVS. I’ll give management kudos to find out they’ve been calling the shots and hitting their targets along the way.

Let’s find out.

Ground Rules

As noted above, CVS management provides relatively detailed guidance. For purposes of evaluating senior leadership, I’ve boiled down deliverables to four specifics:

• Revenue

• adjusted Operating Profit (EBIT)

• adjusted EPS

• operating cash flow

In 2018 and 2019, CEO Larry Merlo’s team emphasized expected revenue, EBIT, and EPS. When Karen Lynch took over, she continued highlighting those metrics in 2020. However, beginning in 2021, she focused more upon operating cash flow than operating profit. Personally, I tend to find cash flow a superior metric to operating profit. Therefore, you will see that change reflected in my research beginning in 2021 and following through to-date.

The Results

Here are tables that summarize the aforementioned for the periods beginning in 2018 and through the current year. Data to populate the charts were generated from archived earnings presentations from the CVS Health’s investor web site.

CVS Health – 2018 Guidance v Actual ($B unless otherwise noted)

Click to enlarge

Actual revenue and EBIT above guidance. Adjusted EPS at upper end of range. The Aetna acquisition closed in November 2018, thereby transforming the company.

CVS Health – 2019 Guidance v Actual ($B unless otherwise noted)

Click to enlarge

Actual revenue, EBIT, and adjusted EPS above guidance. This was ex-CEO Larry Merlo’s last full year in the role.

CVS Health – 2020 Guidance v Actual ($B unless otherwise noted)

Click to enlarge

Actual revenue, EBIT, and adjusted EPS above guidance. Current CEO Karen Lynch took over the CEO role in February 2020.

CVS Health – 2021 Guidance v Actual ($B unless otherwise noted)

Click to enlarge

Actual revenue, operating cash flow, and adjusted EPS well above guidance. The C19 pandemic contributed to the over-performance.

CVS Health – 2022 Guidance v Actual ($B unless otherwise noted)

Click to enlarge

Actual revenue, operating cash flow, and adjusted EPS well above guidance. Another banner year whereby actual results eclipsed management guidance by a wide margin.

CVS Health – 2023 Guidance v Actual ($B unless otherwise noted)

Click to enlarge

Revenue beat guidance. Operating cash flow at the upper end of guidance, while adjusted EPS came in at the lower end. The Signify and Oak Street Health acquisitions were factors in modest YoY EPS growth and a step-down in operating cash flow.

CVS Health – 2024 Guidance v Actual ($B unless otherwise noted)

Click to enlarge

Current year revenue guidance continues to climb. However, operating cash flow and adjusted EPS are expected to contract.

Summary and Conclusions

The results, when looked upon as part of a long-term continuum, tell a story.

• Management has done a fine job of setting financial expectations, then meeting or beating it. Nonetheless, 2023 results were softer versus guidance than 2021 and 2022, when actual results blew out management forecasts.

• On the other hand, the underlying guidance trends have not been positive. To the good, top-line revenue continues to rise due to acquisitive activity and building the business. However, operating cash flow peaked in 2021 and has registered multiple years of meaningful declines. Some of this may have been attributed to the C19 pandemic skewing health care demand; and the company is now experiencing a reversion to the mean. Nonetheless, it’s management hasn’t guided cash flow growth since 2020. Meanwhile, adjusted earnings flattened out in 2023. This year’s management forecast indicates an EPS decline. Not good.

• Indeed, revenue growth coupled with reduced cash flow and flat earnings indicate margin compression. This was evidenced in the 2023 full year earnings release. The 2023 net margin fell to just 3.1 percent versus 3.7 percent in the year prior. 2023 operating cash flow margins dropped to 3.7 percent from 5.0 percent in 2022. Compounding matters, CVS’ business segments tend to be relatively low margin in the first place. 2024 guidance suggest a continuation of this trend.

What does this mean to investors?

CVS management is adept at forecasting fundamental financial performance a year in advance. On the other hand, the underlying trends are uninspiring. This may be a product of “buy-absorb-integrate-deleverage” playbook.

In response, investors have taken a “show me” attitude; thereby squashing valuation multiples.

The current blended operating-adjusted P/E is 8.6x and the P / OCF multiple is 7.3x. A 9x price-to-earnings ratio suggests a company with zero growth prospects.

CVS stock isn’t getting much love and may not until management completes the Signify / Oak Street absorb-integrate-deleverage cycle. I contend investors are looking for earnings and cash flow growth; along with improved margins. This is unlikely to happen quickly.

Therefore, CVS the company and the stock remain a work-in-progress. Management appears capable, conservative, and homed in upon a set of strategies. Furthermore, they do not see the world through rose-colored glasses. These are long-term positives.

Therefore, current or prospective investors must decide if they’re willing to be patient. Current CEO Karen Lynch and her team are building upon the vision of Larry Merlo: CVS will become a verticalized healthcare company focused upon overall individual health care solutions.

A 3.6 percent dividend yield pays investors to wait.

However, I believe the stock is now a “hold” or starter position until management begins to project earnings and cash flow growth coupled with improved margins. The Signify / Oak Street Health deals need time to ferment and get traction; which I believe they will.

On balance, I remain constructive on the shares.

Please do your own careful due diligence before making any investment decision. This article is not a recommendation to buy or sell any stock. Good luck with all your 2024 investments.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.