Introduction:

The combination of CVS Health (CVS) and Aetna (AET) is proving to be a success after initial skepticism by investors. CVS has broken out recently due to a string of better than expected quarters in part attributable to the Aetna acquisition. CVS is generating large amounts of free cash flow, paying down debt and returning value to shareholders in a variety of ways. To further boost long-term growth prospects, restore growth and fend off potential competition, CVS combined with Aetna. This combination creates the first through-in-through healthcare company, combining CVS's pharmacies and PBM platform with Aetna's insurance business. The new CVS combines its existing pharmacy benefits manager (PBM) and retail pharmacies with the second-largest diversified healthcare company.

This is a bold and hefty price tag to pay yet necessary to compete in the increasingly competitive healthcare space, changing marketplace conditions and political backdrop with drug pricing pressures. CVS made a defensive yet necessary acquisition to enable the company to go back on the offensive. CVS had been beaten down for years, plummeting by over 50% ($113 to $52) from its multi-year highs. As of late, CVS has broken out to the mid $70s on the heels of its positive string of earnings. At current levels, CVS presents a compelling investment opportunity while the company is still in the early stages of its CVS-Aetna combination which drive shareholder returns.  

Challenging Backdrop:

The pharmaceutical supply chain cohort, specifically CVS, has been unable to obtain a firm footing in the backdrop of consolidation within the sector, legislative negative undertones, drug pricing pressures, rising insurance costs and a market that has lost patience with these stocks. All of these factors culminated into sub-par growth with a level of uncertainty as the sector continued to face headwinds from multiple directions. Many of the stocks that comprised this cohort presented compelling valuations in a very frothy market. This allure had been a value trap as these stocks continued to disappoint. It’s no secret that these companies have been faced with several headwinds that have negatively impacted the growth and the changing marketplace conditions have plagued these stocks.

The political backdrop has been a major headwind for the entire pharmaceutical supply chain (i.e. drug manufacturers, pharmaceutical wholesalers and pharmacies/pharmacy benefit managers). Exacerbating the political climate, the drug pricing debate continues to rage on throughout political and social media circles weighing on sector. This backdrop erodes pricing power and margins of drugs that ultimately move from drug manufacturers to patients with insurers and other middlemen playing roles in the supply chain web. In an effort to address these headwinds and restore growth, companies have made bold moves such as CVS acquiring Aetna to form one of the largest healthcare companies. Making bold acquisitions to restore growth may be the most viable means to heed competitive threats (i.e. Amazon with Pill Pack) and fend off headwinds. CVS will play an instrumental role in the future of healthcare and will have a growth runway in front of the company as healthcare spending continues to rise. Now that growth has been restored at CVS with Aetna being fully integrated to yield a fully functional bumper-to-bumper healthcare colossus, the stock has broken out.

CVS Enterprise Synergies:

With the enterprise synergies via the Aetna combination, the newly formed CVS is beginning to unlock value and growth over the long-term. This value creation will come through medical cost savings, membership expansion, customer retention, expanded customer value, and partnerships. This can already been seen from its recent string of quarterly reports. Specifically, its full-year 2019 highlights saw total revenues increased 32% to $256.8 billion, GAAP operating income increased to $12.0 billion, operating income increased 36.2% to $15.3 billion and generating cash flow of $12.8 billion.

"As we work to transform the way health care is delivered to millions of Americans, we are driving continued business performance and generating positive momentum across the enterprise. Our fourth quarter and full-year financial results reflect strong financial and operational execution and a successful first year of integrating the Aetna business. We're using our unmatched capabilities to create a higher-quality, simpler and more affordable health care experience, which benefits patients, clients and consumers and positions the company for continued success," CEO Larry Merlo

Figure 1 – Q4 2019 earnings highlights 

Figure 2 – CVS paying down debt and returning value to shareholders

Summary:

CVS Health has been beaten down for years plummeting by ~50% from its multi-year highs. The single-payer narrative being pushed by presidential frontrunners and the Amazon threat via its acquisitions of PillPack/Whole Foods potentially displacing traditional pharmacies weighed heavily on these companies. Additionally, drug pricing pressures are eroding margins and limiting margin expansion over time along with the secular decline in the physical storefront retail space is hindering foot traffic and same-store sales growth. The culmination of these factors resulted in CVS being pressured from all directions. To boost long-term growth prospects, restore growth and fend off potential competition, CVS combined with Aetna. Now, this pharmaceutical supply chain heavyweight is not only surviving but competing and reviving its dominance in the marketplace now that its combination with Aetna has been fully integrated. The combination of CVS Health and Aetna is proving to be a success as CVS has broken out recently due to a string of better than expected quarters in part attributable to the Aetna acquisition. CVS is generating large amounts of free cash flow, paying down debt and returning value to shareholders in a variety of ways. I feel CVS is early in its transformation and presents value coupled with a solid growth profile for the long term investor.