Shares of healthcare giant CVS Health (CVS 2.31%) have been in a free fall this year. The company has failed to impress investors with its earnings numbers and has slashed its guidance multiple times. It has also made a change in CEO recently.
However, with so much bearishness priced into its valuation these days and the stock trading at multi-year lows, there is a contrarian case to be made that it may be a potentially undervalued stock to own, if you’re willing to buy and hold for the long term. Is CVS stock worth the risk?
Why CVS Health stock is struggling badly
Year to date, CVS Health stock has declined by 32% heading into this week, and it’s trading around levels it hasn’t been at since 2019.
The business has been dealing with an increase in medical expenses for patients covered by its Aetna health insurance unit. A key ratio for investors is the medical benefits ratio (MBR), which indicates how much it is spending to provide care in relation to the premiums it is collecting. For the period ended Sept. 30, that ratio was 95.2% — significantly higher than the 85.7% CVS reported in the prior-year quarter.
The company is also in the midst of an overall restructuring program aimed at cutting costs and improving efficiency. While the CVS grew sales last quarter by more than 6%, its adjusted operating income declined by 43%, largely due to the increase in medical expenses and restructuring charges. The company is cutting hundreds of pharmacy retail locations as part of its efforts to become leaner.
Competition is mounting from online retailer Amazon, which recently announced that by the end of next year, same-day prescription delivery would be available to close to half of the U.S. That could diminish the need for people to go to their local pharmacy, whether it be CVS or another business.
CVS faces a tough, uncertain road ahead. It has a new leader at the helm in David Joyner, who took over in October, replacing Karen Lynch. It comes after CVS has not just missed expectations for multiple quarters but also reduced its guidance along the way. It’s evident that management is having a hard time grasping the challenges ahead and predicting how well it may do in the near future.
The company won’t provide guidance for 2025 until sometime next year, when the new CEO has more time to assess the situation.
CVS is cheap — but do its multiples still matter?
If a company’s earnings are constantly underperforming and guidance is getting trimmed, it becomes difficult for analysts and investors to project just how good a value buy the business really is. For example, based on a forward price-to-earnings multiple of just 7, CVS might appear to be an incredible bargain buy. But that’s based on analyst projections of future profits — and an analysis of where the business might be in a year is proving to be exceedingly difficult.
CVS is also trading at a price-to-book multiple of 0.9, but that too may not be all that indicative of value if it writes down its assets due to impairment charges as a result of more challenging industry conditions. The situation is so dire at CVS that the company is also undergoing a strategic review. This may involve breaking up its business, which currently includes pharmacy retail operations, health insurance, and pharmacy benefits management.
Should a breakup occur, that would have a number of possible effects on its competitiveness, which could affect the value of its assets.
Is CVS Health worth investing in today?
CVS has the potential to be an underrated buy given the beaten-down price it’s at today. But in order for that to be the case, management has to prove it has a firm handle on the situation. It must show that it can improve upon its MBR and find a way to improve its overall margins while being competitive as Amazon ramps up its healthcare efforts.
As of right now, it’s far too early to tell what will happen to CVS and where the business might be in the next few years. Although its valuation is low, investors should demand a discount for the healthcare business given the uncertainty it faces. If you have a high risk tolerance and are willing to take a chance on CVS, it could make for a good contrarian investment. Most investors, however, are likely better off either pursuing safer stocks, or at least waiting to see how the new CEO fares next year before making a decision.
John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. David Jagielski has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon. The Motley Fool recommends CVS Health. The Motley Fool has a disclosure policy.