The stock trades at a discount and is near its 52-week low, but is it too risky to invest in CVS Health today?
When a company falls short of earnings expectations, it’s not a good sign for investors. It’s even worse if it also cuts guidance due to a troubling outlook.
CVS Health (CVS 1.37%) has done that for three consecutive periods. Investors are likely losing trust in the company’s ability to forecast what will happen, given the seemingly ever-changing landscape for the business.
Either the business faces difficult headwinds that make it challenging to predict how it will perform, or management hasn’t been good at forecasting its numbers. Regardless of which answer is correct, investors could be led to the same ultimate decision — CVS isn’t worth investing in.
Is the healthcare stock destined to go lower? Are you better off avoiding it, or could it be a good contrarian buy?
CVS’ medical expenses continue to rise
As the healthcare industry has been recovering from the pandemic and operations have resumed normal day-to-day operations, there’s been an uptick in surgeries that were delayed in recent years. Medical costs have also increased during that time, and that is evident with CVS’ medical benefits ratio rising from 86.2% a year ago up to 89.6% this past quarter. And it was on the health benefits side of things (which includes its insurance products and services) where CVS saw the most weakness last quarter with respect to operating income:
| Segment | Operating Income | % Change From Prior-Year Period |
|---|---|---|
| Health Care Benefits | $574 million | -51% |
| Health Services | $1,766 million | 0% |
| Pharmacy & Consumer Wellness | $1,179 million | -13% |
Source: Company filings.
While there was some softness on the pharmacy and consumer business for CVS, it was health benefits which was responsible for the bulk of the decline in operating income during the period. With a diverse business, CVS may not be in terrible shape and the challenges with respect to rising medical costs may not necessarily be a long-term problem for the company.
Earlier this month, CVS reported its latest earnings numbers. While the company beat expectations on its adjusted earnings per share ($1.83 versus $1.73), it downgraded guidance for the full year, yet again. The company now projects that full-year adjusted per-share profit will be in the range of $6.40 to $6.65. In the previous quarter, it slashed guidance from at least $8.30 to $7 per share or higher. This recent adjustment marks the third straight period when CVS has adjusted its outlook downward for 2024. At the end of last year, the company expected adjusted earnings per share of at least $8.50 for 2024.
However, CVS’ ability to beat expectations despite the adversity suggests that the business may still not be doing as badly as analysts may be fearing (perhaps due to low expectations after a couple of guidance cuts) and that there could already be a lot of bearishness priced into their estimates.
Management shake-up suggests more drastic moves could be coming
By routinely adjusting guidance, the company isn’t instilling confidence in investors that it has a good grasp of its business and where it’s headed. One consequence of all these guidance adjustments is that CVS CEO Karen Lynch is going to take over managing Aetna when current Aetna President Brian Kane leaves the company.
Lynch told investors on the company’s recent earnings call that she wasn’t pleased with the results thus far. “We are disappointed by the current performance and outlook for the healthcare benefit segment, and I have decided to make leadership changes effective immediately.”
That could be welcome news for investors, knowing that the CEO is taking the matter seriously. However, without a more permanent replacement, it potentially stretches the CEO too thin and may divert her attention away from other initiatives and growth opportunities. The company says in the long run, it intends to cut $2 billion in expenses as it looks to improve its bottom line, and more drastic moves could be coming when the CEO takes over the reins at Aetna.
Is CVS Health too volatile of a stock to invest in right now?
In the past 12 months, shares of CVS are down 24%. Guidance cut after guidance cut is a surefire way to destroy a stock’s valuation.
When Lynch takes over at Aetna, it could potentially stop the bleeding and allow the company to take a closer look at its forecasts and where there are potential gaps and/or mistakes in the process. If the company can prevent more surprises and drastic guidance cuts from taking place, it could mitigate some of the near-term risk for CVS investors.
Shares of CVS Health are trading around 2020 levels and at a discount to analysts’ earnings expectations. The stock trades at just eight times its estimated future profits. However, its future profit numbers are questionable right now, so investors shouldn’t be too comfortable with any estimates. There is, however, a good margin of safety there, even if the valuation still isn’t factoring in all the headwinds the company faces.
There is some risk with CVS, but I still like the stock in the long term, given how robust and diverse the company is in its healthcare operations. The company’s business units outside of health benefits didn’t perform terribly, and beating expectations this past quarter does indeed suggest that there’s already a lot of bearishness factored into its current price; with the bar set so low, it might not be difficult for CVS to deliver a positive surprise in future quarters.
It can undoubtedly continue to be a bumpy ride for the business and its shareholders. Still, considering the stock’s depressed valuation, investors who take a chance on CVS right now could potentially set themselves up for some great returns in the long run.
