CVS Announces CEO Transition and Boosts 2020 Outlook

Narrow-moat CVS Health CVS turned in third-quarter results that beat expectations and allowed it to boost its 2020 outlook for the second time this year, including for cash flows. Also, the company announced a CEO transition, with the head of the legacy Aetna operations, Karen Lynch, planning to take over for long-term CEO Larry Merlo when he retires in early 2021. We think this transition emphasizes the growing importance of treating consumers holistically at CVS. Importantly for investors, we are keeping our fair value estimate intact and still view CVS shares as undervalued at 8 times 2020 expected earnings and a dividend yield over 3%.

CVS beat quarterly expectations primarily on strength in its pharmacy benefit management operations related to better purchasing economics and specialty pharmacy growth combined with solid retail pharmacy operations, which were offset somewhat by increasing utilization and pandemic-related costs in its Aetna operations. In the quarter, revenue reached $67.1 billion (3.5% growth), above Capital IQ consensus of $66.5 billion, and adjusted earnings per share hit $1.66, above consensus of $1.34. As a result of these strong trends, management raised its 2020 outlook for EPS (to $7.35-$7.45 from $7.14-$7.27 previously) and operating cash flow (to $12.75 billion-$13.25 billion from $11.0 billion-$11.5 billion previously). We have raised our outlook for 2020 in line with that new guidance.

However, we have not changed our assumptions significantly beyond that, as management walked back the jumping off point for mid-single-digit growth in 2021 to $7.10 in 2020, adjusting for COVID-related benefits and a recent divestiture. Therefore growth may be modest next year, and the company still appears to only be working toward double-digit earnings growth by 2022. Its insurance peers regularly achieve that growth rate or higher now, and we suspect CVS' shares may remain constrained relative to fair value until profit growth accelerates materially.

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