CVS Health: The Core Business Model Is In Trouble (NYSE:CVS)

Well-run companies are hard to find, and corporations with good management teams in growing industries are even more difficult to come by. While some industry leaders have strong leadership, good investments are usually found in parts of the economy that are growing as well.

CVS Health Corporation (NYSE:CVS) has been one of the best-run retail companies in the US for some time in the healthcare sector.

CVS has grown significantly over the decades, with the company’s most recent significant expansion being the acquisition of 1600 clinics and pharmacies from Target in 2015. CVS’s revenues rose from $153.29 billion in 2015 to $268.7 billion in 2020.

CVS also saw a huge increase in business during the pandemic, as people getting vaccines after COVID hit frequently shopped inside the company’s stores for other retail goods as well. Still, as the pandemic waned and fewer people came to the company’s stores for booster shots and to shop, CVS’s earnings have returned to pre-pandemic levels and the corporation’s core business is in decline.

Today I rate CVS a sell. The company’s core business model is broken, and even though this retail company is better run than struggling peers such as the Walgreens Boots Alliance (WBA) and Rite Aid (OTC:RADCQ), CVS is still likely to struggle to compete against larger competitors such as Amazon (AMZN), Walmart (WMT), and Costco (COST). The retailer also looks overvalued when looking at current growth estimates and risk moving forward.

CVS saw a significant increase in-store traffic during the pandemic starting in early 2020, and the company was able to boost earnings significantly during this time period.

CVS’s net margins also hit an impressive level of 3.13% during the pandemic, which was at a multi-year high for the retailer.

Still, CVS has struggled since the middle of 2021, as the lower demand for vaccines has caused store traffic to drop, and inflation has also led customers to look for cheaper prices offered at discount retailers such as Costco and Walmart. The company also now faces the prospect of increased competition from Amazon as well, since the leading online retailer recently completed the acquisition of One Medical for $3.9 earlier this year.

CVS’s acquisition of Aetna gave the company competitive advantages against retailers such as Walgreens, but the company won’t likely be able to compete with the many competitive advantages Amazon has. CVS closed 244 stores between 2018 and 2022, and management announced in 2021 that the company plans to close another 900 stores by 2024. The company is currently trying to transform its business model into that of a large healthcare company.

The company’s recent earnings report should also concern investors. Even though CVS slightly beat third-quarter revenue expectations, and reported revenues of $89.76 billion, which was higher than consensus estimates of $88.17 billion. The company missed earnings per share GAAP actual by $.05 a share, reporting $1.75 a share in earnings versus expectations of $1.80 a share. Management also still lowered guidance for the full year and issued several alarming statements. The company stated that the retailer expects demand for new vaccines to continue to moderate through the end of the year, and same-store traffic in the front of the store was already down by 2.2% on a year-over-year basis primarily because consumers were buying less over the counter Covid tests the last several months. Walgreens Boots Alliance also similarly reported a significant drop in vaccine demand over the last year as well.

This is why CVS looks overvalued at current levels. The retailer currently trades at 10.31x expected forward earnings, 8.83x forward EBIT, and 7.55x forward cash flow.

Analysts are only expecting the company to be able to grow earnings by 6% per year over the next 5 years, and even those estimates are likely overly optimistic since Amazon and even companies such as Walgreens are likely to continue to compete with CVS. Amazon has many logistic advantages over CVS, including the ability to deliver medications the same day more efficiently, and CVS is already seeing notable declines with in-store traffic. The company’s in-store products are also more expensive than the prices offered by retailers such as Costco and Walmart. Earnings estimates are likely too high.

CVS is well run, but the company’s core business model faces significant structural challenges as an aging customer base continues to look at online options more and store traffic continues to fall. While the retailer saw a significant increase in earnings during the pandemic, increased competition and falling in-store traffic are a bad combination for what is already a slow-growth business.