CVS Health

Moat: 2.5/5

Understandability: 2/5

Balance Sheet Health: 3.5/5

CVS Health is a diversified healthcare company operating a large pharmacy chain, a health benefits segment, and a pharmacy benefits management (PBM) business.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

CVS Health operates through three core segments: Health Care Benefits (primarily through Aetna), Pharmacy Services (primarily through CVS Caremark), and Retail/LTC (CVS Pharmacy stores & Long Term Care). This diversified structure is intended to provide integrated healthcare solutions.

  • Health Care Benefits: This segment primarily offers healthcare insurance products and related services through Aetna. It’s a major player in the health insurance market, offering commercial, Medicare, and Medicaid plans.

  • Pharmacy Services: This segment includes CVS Caremark, a Pharmacy Benefit Manager, which manages prescription drug benefits for employers and other health plans, including formulary management, mail-order pharmacy, and specialty pharmacy services.

  • Retail/LTC: This segment encompasses CVS Pharmacy retail stores, where it sells prescription drugs, over-the-counter medications, health products, and general merchandise, as well as minute clinic locations. Long-Term Care (LTC) services focus on providing pharmacy services to long-term care facilities.

A crucial part of CVS business is the provision of health care services, such as vaccines and screenings through its retail and minute clinics, and it also helps consumers manage their medications.

Industry and Competitive Landscape

The healthcare industry is complex and highly regulated, with various players operating in overlapping and sometimes competing segments.

  • Competition: In the pharmacy business, CVS competes with large national chains like Walgreens and regional players, and also faces competition from smaller, independent pharmacies. In PBM, they compete with companies like Express Scripts and UnitedHealth Group. In Health Care Benefits, competitors include UnitedHealth, Cigna, and Humana. Online pharmacies like Amazon are also increasing the competitive pressure.

  • Industry Trends: The industry is seeing an increasing focus on value-based healthcare, where payments are tied to health outcomes rather than the volume of services provided. Additionally, there is increasing emphasis on care delivery at non-traditional locations and integrated care models to improve quality and manage costs. The growth of digital health solutions is also having an effect on this industry.

CVS is trying to adapt to the value-based care delivery trend by focusing on its healthcare service business.

  • Pricing Pressure: Competition in prescription drug benefits and retail pharmacy businesses has caused increasing pricing pressure. Moreover, drug pricing is subjected to government regulations and is facing high scrutiny. A number of states have passed a law putting caps on insulin prices for type 1 diabetics, further lowering the company’s revenue.

  • Acquisitions: The healthcare industry also been affected by various acquisitions. The most recent acquisition for CVS is of Signify Health, which provides patient data and at-home care. The company is banking on acquisitions to grow revenue as well as improve long-term sustainability.

Financial Analysis

CVS’s financial performance is a tale of a company with steady revenues and some earnings growth, but also under substantial pressure because of the changing economic landscape, pricing pressures, and the increased competition, especially from tech companies.

  • Revenue Distribution: The company has a diverse revenue base, with revenues coming from all three core segments. The majority of its revenue comes from the Pharmacy Services and Health Care Benefit segments.

  • Operating Margins: The company’s overall operating margins are below 10%, although a variety of business lines such as pharmacy and retail offer a significantly higher margin, in the mid-teens. Furthermore, Health Care Services operates on lower margins of 4-6%, which is common in the insurance industry.

  • Debt: The Company has taken on huge amounts of long term debt in the last few years to acquire companies. As of the last filing, CVS has more than $53 billion in long-term debt and about $6.5 billion in short-term debt. Most of its debt has a fixed interest rates, which means the company has minimal exposure to short-term interest rates rises.

  • Goodwill & Intangible Assets: Following recent acquisitions the company’s balance sheet has $124 billion in intangible assets, of which nearly $84 billion is goodwill from the previous acquisitions.

  • Cash Flow: Despite a growing business, CVS’s operational cash flow has been on a downtrend in the last couple of years, going from $17 billion in 2021, to $15.3 billion in 2022, and $10.2 billion in 2023.

Moat Rating: 2.5/5

CVS possesses a narrow moat, but the strength and longevity of that moat are unclear.

  • Intangible Assets (Narrow): The most important moat for CVS comes from its well-known brand and retail pharmacy location. The customer is typically familiar with the company’s store and has a certain level of trust. The other factor is the location where the company operates in a convenient location. The convenience and trust factor is the moat that the company is operating on. However, this moat is limited because customers are not necessarily willing to pay a premium for their convenience and generally care about prices. It is not easy, nor impossible, for a competitor to replicate CVS’s footprint, brand, and relationships.

  • Switching Costs (Limited): Switching costs for most retail pharmacy or PBM customers are low, since most people have several options to choose from, with similar quality.

  • Scale Advantage (Limited): The scale of a large company, as we have mentioned, enables it to capture economies of scale which could potentially improve its value. Even in the case of a pharmaceutical chain, the margins are typically very low. So while a large company like CVS has better bargaining power with its suppliers and vendors compared to its smaller competitors, the amount of margin they can actually gain is not that significant, compared to other industries.

  • Network Economics: This aspect of the moat is limited to Aetna and its healthcare benefits segment. A larger and more widespread network can potentially lead to a better service for the customers and attract more new members.

Risks to the Moat and Business Resilience

Several risks could severely harm CVS’s competitive position and business resilience:

  • Regulatory Changes: As a healthcare provider, most of its revenues are determined by government regulations. A change in government regulation or policy regarding payment, rebates, or drug prices could have a severe impact on company’s revenues and margins. Most recently, the government is working on regulations that will significantly limit the price of insulin for type 1 diabetics.

  • Competition: The most concerning risk to CVS business comes from its increasing competition, especially from tech companies and other big players, such as Amazon, which have been exploring opportunities in the pharmacy and health-care market.

  • Technological Disruption: Technology changes rapidly, and changes in customer expectations and preferences may make certain business models obsolete. Moreover, this could make companies that are focused on providing digital solutions more relevant.

  • High Debt Levels: Due to the recent aggressive acquisitions, the company has taken on huge debt which can make it vulnerable to downturns in the economy.

  • Inflation: Higher costs can potentially lead to higher prices and lower profits if the business cannot absorb them or pass them to consumers.

Understandability Rating: 2/5

The business structure of CVS is complex. For an average investor, it could be hard to fully understand the complicated and intertwined relationships of the three segments. The recent aggressive acquisitions and the shift to technology driven health care will only make it harder for them to understand what’s happening in the business.

Balance Sheet Health: 3.5/5

CVS’s balance sheet has some strengths but also areas of concern. The company has a lot of goodwill on the balance sheet, and it has taken a lot of debt to execute its acquisition strategy. However, the company seems to have the ability to pay-off the debt in time, but the debt load does add an additional layer of risk to the company’s finances.

  • Debt: While CVS does manage to keep up with its debt obligations, the company has very high amount of debt.

  • Cash flows: The company has historically shown decent free cash flows, which enable them to manage debt and pay dividends, it needs to be observed whether the declining free cash flow will become a problem in the upcoming years.

  • Goodwill & Intangibles: Goodwill and acquired intangibles make up for a big portion of the balance sheet, which means that if some of those acquisitions are not successful the company would have to write-off billions of dollars, reducing their assets on the balance sheet.

Recent Concerns / Controversies

The company’s recent earnings calls have highlighted that the company is facing some challenges with inflation and labor costs. Moreover, there have been some recent concerns from analysts about the declining growth rates of the company as it shifts into a mature business. Furthermore, due to the current pricing dynamics of drugs, investors have started wondering if the Pharmacy Services segment will be as profitable as it was before.

The company’s management has mentioned that they are taking steps to improve profitability and also are focusing more towards new business avenues such as primary care and the value-based care model.