CVS Health (NYSE: CVS) is a fascinating hybrid of a company. It is a health insurance company that owns a chain of pharmacies.
CVS is about grow a lot bigger because the U.S. Justice Department has approved its acquisition of Aetna (NYSE: AET). Aetna, unlike CVS, is purely a health insurance company.
The idea is to create a private enterprise that functions something like Britain’s National Health Service (NHS). That is one stop shopping for all your health insurance and healthcare needs. The NHS operates hospitals and provides health insurance in the United Kingdom.
CVS is more like the NHS than many people think; it already operates more than 1,100 MinuteClinic walk-in healthcare facilities, for example. There are MinuteClinics in 33 states and the District of Columbia that have received more than 37 million visits.
Is CVS Health Desperate to Contain Costs
Such a move will have many investors if CVS Health is making money. The questions arise because the acquisition will reputedly cost $69 billion.
Bears will ask “why would CVS spend that kind of money if it was making money with its existing business.” An obvious reason for the acquisition is to contain healthcare costs which are spiraling out of control.
Healthcare costs could quickly overwhelm CVS which manages 94 million prescription plans. To increase the danger, five million people reputedly visit CVS pharmacies each day.
Investors and healthcare consumers will want to know why is CVS so desperate to contain costs? Skeptics will note that healthy companies do not attempt drastic moves like the Aetna acquisition.
Is CVS Making Money?
On paper, CVS is making a lot of money; it reported $184.8 billion in revenues for 2017.
CVS generated $45.693 billion in revenues during the 2nd Quarter of 2018 alone. Those revenues were down from $48.385 billion during 1st Quarter 2018.
Despite those huge numbers, CVS is not making that much money it reported a net income of $998 million on March 31, 2018. That number was down from $3.287 billion on December 31, 2017.
There was also an operating income of $1.943 billion; which seems low given CVS’s gross profit of $6.859 billion, for 2nd Quarter. The obvious conclusion is that CVS is not making much money.
CVS reported free cash flow of $1.875 billion and an operating cash flow of $2.355 billion for 2nd Quarter 2018. Disturbingly, the company reported a financing cash flow of $38.14 billion for the same period. That means CVS just borrowed $38.14 billion presumably to finance the Aetna deal.
Despite the low income, CVS has a lot of money in the bank. It reported $42.023 billion in cash and equivalents on March 31, 2018. That number sounds impressive until you realize where that money came from CVS borrowed it.
CVS had reported just $1.696 billion in cash and equivalents on December 31, 2017. Therefore, the only way CVS can raise a lot of cash is to borrow the money.
Why is CVS not making that much Money?
The reason CVS is not making much money is its high cost of operations. The company claimed to operate 9,800 retail locations and employ 246,000 people on July 15, 2018.
Many of those employees are very highly paid, unlike typical retail workers. The average U.S. pharmacist made between $112,000 and $119,000 a year in 2015, The Pharmacy Times calculated. The lowest paid pharmacists made around $90,000 a year in 2015.
Presumably, CVS employs at least one pharmacist at every location, which means 9,800 high salaries. Other highly paid employees at CVS include pharmacy technicians, nurses, and the nurse practitioners in the MinuteClinics.
Can CVS Compete with Amazon, Berkshire Hathaway and JPMorgan Chase?
CVS faces very high labor costs at a time when it faces potential competition from Amazon (NASDAQ: AMZN), Berkshire Hathaway (NYSE: BRK.B), and JPMorgan Chase (NYSE: JPM).
Warren Buffett, Jeff Bezos, and Jamie Dimon reportedly want to create a health insurance plan to cover their employees. Bezos obviously wants to go even further; Amazon has purchased the online pharmacy Pillpack for $1 billion. Pillpack reportedly has a license to operate in all 50 states and $13 billion in sales.
That sounds like Bezos is building his own version of CVS Health, an insurance company that owns pharmacies. That venture would have the backing of America’s largest bank, JPMorgan Chase and Berkshire Hathaway.
Since Berkshire Hathaway is already a major player in insurance that is a major headache for CVS Health. A real danger would be if Amazon and its partners buy a brick and mortar pharmacy.
Are Amazon and Berkshire Hathaway planning a Retail Alliance
A possible target would be the ailing Rite Aid (NYSE: RAD) which collapsed. Another target is Fred’s (NASDAQ: FRED) which has bought a lot of Rite Aid’s assets. Buying a pharmacy chain would make sense because Berkshire Hathaway owns the McLane Company a major supplier to retail stores.
The pharmacies could easily be converted into pickup locations for Amazon orders or Amazon Go automated stores. A chain of Amazon Go stores serviced by McLane sounds like a logical business.
Even more problematic would be an alliance between the Amazon/Berkshire/Chase venture and a major retail pharmacy. The obvious contenders here are Walgreens (NASDAQ: WBA), Kroger (NSYE: KR), and Walmart (NYSE: WMT).
Working with Walgreen or Kroger, which operate clinics in some of their stores, would make a lot of sense for Amazon. So, for that matter, would be an alliance with CVS.
It seems as if Warren Buffett and Jeff Bezos’ ambitions extend behind healthcare. A strong possibility might be an Amazon Go store with a pharmacy and a Chase bank inside. One has to wonder how CVS would compete with thousands of such locations across America.
Mr. Market’s jitters about Amazon and Berkshire’s entry into the pharmacy sphere seem to well be founded. Amazon’s health venture has some impressive brainpower and financial backing behind it. The trio of billionaires has recruited celebrity surgeon, researcher, and author Dr Atul Gawande as the CEO of the unnamed joint venture.
Medicare for all Threatens CVS Health
If that wasn’t bad enough there’s an even greater Black Swan that can totally disrupt CVS’s business. That Black Swan is single-payer health insurance or federal health insurance for all Americans.
That Black Swan might arrive sooner than people think. Almost every potential Democratic Presidential candidate and most Democratic senators have endorsed “Medicare for All.” It is easy to see why polls indicate 62% of voters want Medicare for All.
What that means for pharmacies and health insurance unclear because nobody knows what it Medicare for All would be. It might be expansion of existing systems like Medicare or Medicaid, government subsidies for private insurance, or a new system.
No matter what happens it means a completely new business model for healthcare which will be expensive and disruptive. Medicare for All might help CVS by ensuing that most prescriptions and procedures are paid for. Single Payer would presumably lower profits by controlling costs.
Is CVS a Value Investment?
Given these realities one has to wonder if CVS is a value investment. After all, Berkshire Hathaway (NYSE: BRK.A) which combines retail and insurance is very profitable.
Buying Aetna would give CVS a stream of constant revenue from insurance premiums. Warren Buffett refers to insurance premiums as float; a stream of cash that a company can access for growth, or financing. Aetna would give CVS a lot of float and make it sort of like Berkshire Hathaway.
CVS is also in a business that Buffett and Bezos want to enter health insurance and healthcare. More importantly, its stock was fairly cheap at $67.92 a share investment on July 17, 2018.
I would say CVS Health is a value investment because of the low price and dividend. CVS shareholders are scheduled to receive a 50¢ payout on August 1, 2018. CVS is also a highly diversified company with four distinct businesses pharmacies, retail, clinics and prescription plans. It is about to add a fourth in the form of health insurance.
That makes CVS one of the more interesting value investments around these days. Everybody that wants a diversified moneymaker in his or her portfolio should investigate CVS Health (NYSE: CVS).