Valuations

  • 11 Jan
    Is LRCX a big value opportunity, or a big value trap?

    Is LRCX a big value opportunity, or a big value trap?

    Did you study the California gold rush in your high school history class? I did, and I remember that one of the most interesting things to me about it was the fact that over the seven years that marked the period, the people that made the most money weren’t prospectors; they were the entrepreneurs that flocked to the territory to sell equipment and supplies to those prospectors. As an investor, I’ve found interesting parallels to those entrepreneurs in the industries that supply the major sectors of the American economy. More →

  • 11 Dec
    Is FEYE’s upward trend sustainable?

    Is FEYE’s upward trend sustainable?

    Politics have been putting more pressure than normal on the stock market of late; after the Trump administration announced a preliminary agreement with China to halt imposition of any new tariffs at the beginning of this month following the G20 summit in Buenos Aires, the market seemed poised to rise a new wave of bullish momentum and sentiment. More →

  • 10 Dec
    Transports are down 16% since September – but that doesn’t make SKYW a good bargain

    Transports are down 16% since September – but that doesn’t make SKYW a good bargain

    The market hasn’t been kind to the Transportation sector since the end of the third quarter of the year. As measured by the S&P Transportation SPDR ETF (XTN), the sector declined from its 52-week highs at the beginning of September nearly 20% by Halloween before staging a temporary rally through November. Since the beginning of the month, however the sector has dropped back near to its yearly lows. More →

  • 30 Nov
    Food stocks can be a good defensive play – but FDP is a sucker’s bet

    Food stocks can be a good defensive play – but FDP is a sucker’s bet

    Until the beginning of this week, the market seemed to be getting more and more bearish every day. After watching the major market indices all decline by more than 10% in October, they staged a short-lived rally at the beginning of November, only to turn back again with a resounding series of consecutive down days last week that pushed the market once again into correction territory. This week has seemed like something of a respite as the market has has rallied off of lows only a little above the 52-week bottom it reached in April. That could be a good thing, but it isn’t a given, More →

  • 28 Nov
    CVS/Aetna deal just got approved – does that make the stock a buy?

    CVS/Aetna deal just got approved – does that make the stock a buy?

    One of the biggest news items of the day yesterday came when CVS Health Corporation (CVS) announced they had received final regulatory approval for their proposed merger with Aetna Inc. (AET). Announced at the end of 2017, this is an intriguing deal, and not just for the massive $77 billion price CVS is paying for the deal that is expected close this week. Combining one of the largest pharmacy companies with another big player in the heath care provider industry offers the promise of a major shift in the way healthcare is offered and delivered in the United States; it certainly seems to put the combined company firmly at the forefront of a change that could leave the rest of both industries scrambling to catch up.

    Earlier this year, pharmacy and healthcare stocks tumbled amid rumors that Amazon (AMZN) was investigating the potential of entering the business as well. That may still happen, and if it does, that should certainly amplify an already highly competitive industry landscape, but a lot of industry reports seem to indicate those fears may be overblown because of the regulatory challenges AMZN would have to hurdle just to make an initial move into the industry. Even if they do, this merger seems like a proactive, forward-looking move by both CVS and AET to set the standard AMZN and every other company is going to have to measure up to.



    CVS is a stock that has performed pretty well this year – especially when you compare it to the performance of the broad market indices. It’s up almost 10% year-to-date, and nearly 13% in the last month alone. It’s fair to say that the biggest piece of that surge has come from enthusiasm about this pending merger; it’s been widely praised by analysts and industry insiders since it was announced. I’ve also seen a lot of analysts labeling the stock as a terrific value, based primarily on forward-looking estimates of what the combined company should be able to do. Some of that makes sense, I suppose; the real problem, of course is that forward-looking estimates are just that, and nothing more. The truth is that integrating two companies is a challenging task – and that is even when the two companies operate within the same market space as usually happens when a merger happens. Merging two companies in related, but completely separate industries is another matter altogether, and so a smooth integration and transition is certainly not a given.

    There is a lot of promise for the future, to be sure, and the fact is that this is a mega-merger between two large cap stocks that are unquestioned leaders in their respective fields. Each company has significant fundamental strengths they bring to the table, and as a combined company, they offer some interesting potential opportunities, such as the expansion of CVS’ existing MinuteClinics to include AET’s clinical capabilities. Those “concept clinics” are expected to start rolling in early 2019, which means investors generally should have almost immediate feedback to work with in trying to analyze the likely success of the merger. What I want to do with today’s post is to consider what folding AET into CVS’s business structure is going to mean from a fundamental point of view, and from there to try to determine if the resulting company is likely to offer a compelling value to work with.



    Fundamental and Value Profile

    CVS Health Corporation, together with its subsidiaries, is an integrated pharmacy healthcare company. The Company provides pharmacy care for the senior community through Omnicare, Inc. (Omnicare) and Omnicare’s long-term care (LTC) operations, which include distribution of pharmaceuticals, related pharmacy consulting and other ancillary services to chronic care facilities and other care settings. It operates through three segments: Pharmacy Services, Retail/LTC and Corporate. The Pharmacy Services Segment provides a range of pharmacy benefit management (PBM) solutions to its clients. As of December 31, 2016, the Retail/LTC Segment included 9,709 retail locations (of which 7,980 were its stores that operated a pharmacy and 1,674 were its pharmacies located within Target Corporation (Target) stores), its online retail pharmacy Websites, CVS.com, Navarro.com and Onofre.com.br, 38 onsite pharmacy stores, its long-term care pharmacy operations and its retail healthcare clinics. CVS has a market cap of $81 billion. Aetna Inc. is a diversified healthcare benefits company. The Company operates through three segments: Health Care, Group Insurance and Large Case Pensions. It offers a range of traditional, voluntary and consumer-directed health insurance products and related services, including medical, pharmacy, dental, behavioral health, group life and disability plans, medical management capabilities, Medicaid healthcare management services, Medicare Advantage and Medicare Supplement plans, workers’ compensation administrative services and health information technology (HIT) products and services. The Health Care segment consists of medical, pharmacy benefit management services, dental, behavioral health and vision plans offered on both an Insured basis and an employer-funded basis, and emerging businesses products and services. The Group Insurance segment includes group life insurance and group disability products. Its products are offered on an Insured basis. AET has a market cap of about $69.4 billion

    • Earnings and Sales Growth: Over the last twelve months, earnings for CVS increased by about 15%, while sales were mostly flat, increasing about 2%. For AET, earnings increased about 20% in the last year. CVS operates with extremely narrow operating margins, as Net Income was only 1.6% of Revenues for the last twelve months and 2.9% in the last quarter. AET has a wider margin profile, with Net Income that was 5.9% over the last year and 6.4% in the most recent quarter.
    • Free Cash Flow: CVS’s free cash flow is healthy, at about $4.3 billion, while AET’s is more modest, and about $550 million. Both companies have good liquidity, with cash and liquids assets for CVS that totaled $41.6 billion in the most recent quarter, and $9.5 billion for AET over the same period.
    • Debt to Equity: CVS has a debt/equity ratio of 1.66. This is higher than I usually prefer to see, but is primarily attributable to the massive increase in debt the company preemptively took on at the beginning of the year when the merger was first announced. Total long-term debt is $60.7 billion for CVS. AET has $7.7 billion in long-term debt, which is almost $2 billion less than their cash. CVS has also laid out an aggressive debt reduction program that they expect to lower the total debt the combined company will be working with to much more conservative levels early in 2020.
    • Dividend: CVS and AET each pay an annual dividend of $2.00 per share. Whether that means that shareholders in the combined company will get to enjoy receiving a $4 annual dividend remains to be seen; my expectation is that the dividend will remain the same on a per-share basis in order to give the combined company more flexibility in managing their debt service.
    • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for CVS is $35.97 per share. At CVS’s current price, that translates to a Price/Book ratio of 2.21. The stock’s historical average is 2.48, which offers about a 12% upside from the stock’s current price. There is a more compelling argument to be made for the stock on a Price/Cash Flow basis, since the stock is currently trading more than 35% below that historical average. AET, on the other hand, is overvalued based on both its Price/Book and Price/Cash Flow ratios by anywhere from 5% (slightly overvalued) to 50% (very overvalued). Based strictly off of existing, historical information, I expect the combined company to initially be overvalued.



    Technical Profile

    Here’s a look at CVS’ latest technical chart.

     

    • Current Price Action/Trends and Pivots: CVS followed the broad market quite a bit lower in October, but rallied back above its early October high before dropping back a bit until late last week. The market’s enthusiasm for the merger is giving the stock a nice boost right now. Resistance is right at $80, which is almost where the stock is sitting right now. Immediate support is around $69. A push above $80, to about $82 (or whatever price its recent high translates to once the merger is completed), would mark a continuation of the stock’s upward trend since August, while a drop below $74 would mark a reversal of that trend, with a break below $69 representing an indication a new bearish trend could see an extended run. AET, not shown here, has a completely different technical picture, since the stock has been following a very impressive upward trend since February of 2016 and has more than doubled in price over that period.
    • Near-term Keys: CVS is a stock that by most measurements would be considered undervalued, while AET is overvalued. It seems apparent that CVS is consciously paying a big premium for this deal. The potential to transform the healthcare industry is a compelling draw, and it’s safe to say that both companies believe they can thrive in that effort by doing it together. Does that make the stock a bargain right now? I think a lot of investors are going to be jumping onto the stock with exactly that expectation, so don’t be surprised if you see the combined company experience a pretty nice rally in the short-term, post-merger period. Over the next few months, I’ll be watching the financial results pretty closely, to see if they seem to line up with the story both companies have been presenting for the last year. No matter which way it goes, this is a deal that could mark a big turning point for both industries.


  • 23 Nov
    Happy Black Friday! Which stock is a better value right now – TGT or WMT?

    Happy Black Friday! Which stock is a better value right now – TGT or WMT?

    It’s an annual thing – the day after Thanksgiving marks the official start of the holiday shopping season. Anxious to get a jump on the best deals of the season, shoppers line up outside stores all over the country. It also marks a point in the year when the stock market starts to pay even closer attention to the retail sector than normal. More →

  • 30 Oct
    The market is beating up transport stocks – but that also creates opportunity

    The market is beating up transport stocks – but that also creates opportunity

    Back in July, I wrote about Kansas City Southern (KSU), a mid-cap railroad company that isn’t extremely well-known outside of its normal operating region. Transportation stocks were a good bet throughout the summer, but as fall set in, the market has pushed the Dow Transportation Average down a little over 14% since early September. For KSU, who is the smallest Class 1 railroad in the United States, that broader industry decline has translated to a decline in its price as of this writing of almost 18%. More →

  • 29 Oct
    Dogs of the S&P 500? These 3 stocks crashed 20% or more this week but could be good values now

    Dogs of the S&P 500? These 3 stocks crashed 20% or more this week but could be good values now

    The market closed a volatile week with yet another selloff on Friday, and has managed to push both the S&P 500 as well as the Dow Jones Industrial Average nearly into correction territory with the NASDAQ 100. Along the way, investors, analysts and experts everywhere are now asking the question about where the market is going to go from here. Days where the Dow moves 300 points or more in a single day have seemingly been the norm over the last couple of weeks, and that is something that makes the market a hard place for most investors to keep up with. More →

  • 25 Oct
    Fundamental strength alone isn’t enough to make TXN a good buy right now

    Fundamental strength alone isn’t enough to make TXN a good buy right now

    The last couple of weeks have seen market volatility return in a big way, and with it fear seems to be increasing quite a bit this week. I think part of it is because investors are starting to realize how close the market is right now to an important inflection point. As of yesterday’s close, the tech-dominated NASDAQ had officially dropped more than 10% below its last all-time high, which was reached back in late August. To add insult to injury, both the Dow and the S7P 500 have given back almost all of the gains they’ve achieved since the last correction that ended in March of this year, and are now slightly lower for the entire year. More →

  • 16 Oct
    ROST is a market beater – but does that mean you should buy now?

    ROST is a market beater – but does that mean you should buy now?

    One of the most interesting things to me about the stock market is that there really are as many different ways to invest your money as the human brain can imagine. That’s one of the reasons that there are so many different kinds of mutual fund and ETF choices geared for the average investor. One of the reasons that is so interesting is because that reflects another market reality: More →

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