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Grocery Wars

Will CVS-Aetna Make Money?

The CVS-Aetna merger is official. The US Department approved the $69 billion merger between CVS Health (NYSE: CVS) and Aetna (NYSE: AET) on October 10, 2018.

The New York Times speculates the CVS-Aetna merger will dramatically change healthcare. For example, CVS manages 94 million prescription plans and Aetna’s health insurance covers 22 million people.

CVS-Aeta will tighten costs because it will have far more control over healthcare. For instance, CVS Health operates over 9,800 retail pharmacies and around 1,100 Minute Clinics in the United States. To clarify, the Minute Clinics provide basic medical services such as vaccinations and exams in CVS stores.

CVS-Aetna has Vast Market power

Uniquely, CVS already has vast market power. In detail, CVS claims to fill 2.5 billion prescriptions a year and five million prescriptions a day. Thus, CVS-Aetna can dictate market prices for many prescriptions.

In addition, CVS operates the pharmacies in Target (NYSE: TGT) stores. Notably, news stories did not say how the CVS-Aetna deal will affect the Target operations.

In fact, CVS-Aetna’s potential market power is so great New York and California regulators are threatening to block the deal.  Corporate Counsel reports New York regulators are investigating CVS-Aetna and California tried to block the deal.

It concerns the New York State Department of Financial Services because CVS borrowed $40 billion to buy Aetna. To explain, the fear is that CVS-Aetna will raise insurance premiums to repay the loans.

Investors should take note because that shows CVS-Aetna could be financially unstable. For instance, they might redirect dividends to repay loans.

Could CVS-Aetna Make Money?

The financial data indicates that CVS-Aetna will probably make money. For example, Aetna reported a gross profit of $4.5 billion on revenues of $15.561 billion for 2nd Quarter 2018.

In addition, CVS Health recorded a gross profit of $7.201 billion on revenues of $46.78 billion for 2nd Quarter 2018. Therefore, CVS-Aetna could generate a quarterly gross profit of $11.7 billion and quarterly revenues of $62.341 billion.

However, CVS Health recorded an operating loss of -$1.590 billion and a net loss of -$2.563 billion for 2nd Quarter 2018. Meanwhile, Aetna recorded an operating income of $1.684 billion and a net income of $1.212 billion for 2nd Quarter 2018.

Thus, cynics will argue that CVS is trying to cover its losses by buying Aetna. This argument is unconvincing because Aetna-CVS could make an operating income of $94 million and a net loss of -$1.351 billion.

Hence, CVS-Aetna will lose money with the financial numbers both companies reported on June 30, 2018. That makes CVS-Aetna a very dubious stock from a value investor’s standpoint.

How Much Cash does CVS Have?

I think CVS is trying to get its hands on the float from Aetna’s health insurance policies.

To explain, float is a stream of cash flow that a company can spend or borrow against. Notably, Warren Buffett regards insurance premiums as float.

CVS-Aetna will have a lot of float. For instance, CVS Health reported an operating cash flow of $2.934 billion and a free cash flow of $2.509 billion for 2nd Quarter 2018. Moreover, Aetna recorded an operating cash flow of $1.044 billion and a free cash flow of $924 million for 2nd Quarter 2018.

By my calculations CVS-Aetna could have had an operating cash flow of $3.978 billion and a free cash flow of $3.433 billion for 2nd Quarter 2018. Thus CVS-Aetna will have a lot of cash to play with.

CVS Health Borrowed $40 billion to buy Aetna

For instance, Aetna reported cash and equivalents of $7.447 billion and short-term investments of $2.611 billion for 2nd Quarter 2018. Hence, Aetna had $10.058 billion in the bank on June 30, 2018.

Therefore, Aetna has a lot of float which justifies the argument CVS Health bought it for the cash.  However, CVS Health corded $43.911 billion in cash and equivalents on June 30, 2018.

Unfortunately, CVS apparently borrowed that cash. Notably, CVS recorded just $1.807 billion cash and equivalents on December 31, 2018.

This confirms New York State’s allegation that CVS Health borrowed $40 billion to buy Aetna. Obviously, it raises the possibility that debt will eat up CVS-Aetna’s profits.

Is CVS-Aetna a Value investment?

I conclude CVS-Aetna is not a value investment because of the debt. Moreover, the risks in retail will undermine CVS-Aetna’s value.

For example, CVS Health is already competing with Walmart (NYSE: WMT), Kroger (NYSE: KR), and Walgreen Boots Alliance (NASDAQ: WBA). Three of the biggest and toughest retail bullies in the market.

To make matters worse for CVS, Walgreens and Kroger are teaming up to leverage their resources. In detail, Walgreens will offer pickup of Kroger groceries at 15 of its stores in Kentucky.

Beyond that, there is the potential threat from Amazon (NASDAQ: AMZN). Amazon is acquiring the online pharmacy PillPack and opening 3,000 Go automated convenience stores. The Go stores could completely directly with CVS Health and serve as pickup locations for PillPack prescriptions.

Thus, CVS-Aetna will face massive risks in a difficult market filled with aggressive and dangerous competitors. A Kroger-Walgreens alliance will be the most dangerous of those competitors.

To explain, Kroger is the nation’s largest standalone grocer and Walgreens, the largest drugstore operator. For example, Walgreens operated 9,560 drugstores in the United States on 31 August 2018. In addition Kroger operated 2,268 pharmacies in February 2018. Thus Kroger and Walgreen could create a network of 11,828 pharmacies.

Will CVS-Aetna be a Good Dividend Stock?

Theoretically, CVS-Aetna could be a good dividend stock. For instance, CVS Health (NYSE: CVS) will pay a dividend of 50¢ on November 1, 2018. In addition, Aetna (NYSE: AETNA) will pay a dividend of 50¢ on the same day.

Consequently CVS-Aetna could pay a dividend of $1. However, CVS-Aeta needs to pay the $40 billion in debt it took on to buy Aetna.

No investor should expect a $1 dividend from CVS-Aetna soon. My suggestion is that you should avoid CVS-Aetna until it pays down that debt.

Is CVS-Aetna the new Sears?

I have one more very disturbing thought here. CVS-Aetna has a strong resemblance to the sick man of retail Sears Holdings (OTCMKTS: SHLD).

Notably, the bankrupt Sears Holdings started as a merger of two ailing retailers, Sears and Kmart. Tellingly, Sears’ stock was trading on over-the-counter markets at 19¢ a share on October 30, 2018.

Notably, when Eddie Lampert formed  it in 2005, journalists hailed Sears Holdings as an innovative retail hybrid. Just like CVS-Aetna is being portrayed today.

Hopefully, CVS-Aetna will not turn out to be the next Sears. However, retail history shows that such cumbersome hybrids usually end in catastrophe. Thus only investors with a high tolerance for appetite should buy CVS-Aetna if it ever appears in the markets.