CVS Health (NYSE:CVS) is the nation’s largest chain pharmacy retailer, with control of nearly 25% of the market. It also has the reputation as a solid dividend stock with stable and consistent payments. However, CVS has underperformed the market lately, down about 1% over the past year compared to the S&P 500‘s 15% gain.
A large reason behind investors’ skepticism about CVS is the looming competition from Amazon‘s (NASDAQ:AMZN) new online pharmacy. The e-commerce giant has an impeccable track record in disrupting the bottom lines of brick-and-mortar retailers. Luckily, CVS has one trick up its sleeve that would at least ensure the safety of its dividend and core business for the medium term.
A healthy business
CVS’ core operations are growing steadily, mostly due to the COVID-19 pandemic. Since their launch, the company has administered over 10 million coronavirus tests and 700,000 vaccines. It operates over 4,000 testing locations and will soon be administering coronavirus vaccines to over 40,000 long-term care homes.
The company is responsible for administering close to 10% of all coronavirus vaccinations given in the U.S. so far. CVS projects it will have the capacity to vaccinate more people, with up to 25 million doses per month once federal vaccination programs kick in.
In addition, CVS plays a large roll in vaccinating people against influenza. The company saw a 78% year-over-year spike in the number of seasonal flu vaccinations to 13 million in Q3 2020. CVS’ sales also grew by 3.5% in the third quarter of 2020 to $67 billion, and it expects to increase its earnings per share to $7.45 in 2020 versus $7.08 in 2019.
CVS’ best-performing segment isn’t necessarily its retail pharmacies. There are over 23.3 million members of its health insurance plan nationwide, increasing 2% year over year.The company’s subsidiary, Aetna, generates close to $18.7 billion per quarter in health insurance fees, which increased by about 9% compared to the same period last year.
Aetna is arguable one of the most profitable insurers in the industry. It has a medical benefit ratio of close to 84%, which is ideal compared compared to the industry average.
Furthermore, CVS is also highly profitable. It expects to bring in upwards of $13 billion in cash flow from operations for 2020. Back in Q3 2020, it paid back close to $4.75 billion in net debt with cash on hand. The pharmacy giant also aims to target a financial leverage ratio of 3 by 2022.
Financial leverage represents a firm’s net debt divided by its operating income less non-cash items, or EBITDA in common parlance. Usually, a ratio greater than four or five indicates that it may have problems meeting its debt obligations.
Is its dividend any good?
Right now, CVS maintains an impressive dividend payout ratio of 33%. This means the company has more than enough profit to sustain its dividend and have reserve ample leftover capital. Its annual dividend yield is 2.62%, which is much higher than the S&P 500’s average of 1.55%.
Over the past decade, CVS has increased its dividend at a staggering rate of 23% per year. It is also moderately leveraged with a 0.87 debt-to-equity ratio. A value over one could indicate that it may have problems fulfilling its loan obligations in the future. Given the above factors, CVS stock’s dividend is a safe hold for the long term.
Should I buy the stock?
CVS currently trades for a mere 0.4 times revenue and 12 times trailing earnings. For context, its direct peers trade between 16 and 78 times earnings, while Amazon trades at 96 times earnings. Arguably, CVS is quite undervalued, and the enormous opportunity arising from a massive coronavirus vaccine distribution program this year should make the market sit up and take notice. While Amazon’s online pharmacy would be a major competitive force going forward, it doesn’t really have the ability to match CVS when its comes to combating the pandemic.
Overall, CVS is not only an outstanding dividend stock, but also one that has room for capital appreciation. In other words, the large-cap pharmaceutical chain is a superb choice for dividend investors and growth investors alike. Expect shares to outperform this year as vaccine distribution drives revenue growth, and its continued outperformance in health insurance revenue.