Adverse news (Chronological order) 1) CMS has downgraded Aetna's Medicare Advantage plan and other medical insurance agencies.
CVS Health highlighted the impact of the Centers for Medicare and Medicaid Services (CMS) downgrading its PPO plan from its previous 4.5 to 3.5 stars. This decline in rating also implies it will be ineligible for CMS quality bonus payments in 2024 but with no direct impact on 2022 and 2023.
21% were enrolled with four stars in the year 2023. Hence, the company estimates the quantified impact is approximately 800 million to 1 billion. The impact of these on a 15 billion operating margin (projected next year) is significant but still overstated by the news. Under the Affordable Care Act, a portion of MA payments are tied to performance in the star ratings program. Nonetheless, CVS has reiterated that it has minimal impact on guidance for 2022 and 2023, and it will try its best to reattempt the ratings for 2024.
The following news came rumbling in quickly in the same month (October), whereby Cigna won the PBM Contract to Centene against CVS Health.
As per the term, Cigna will manage 20 million Centene members, coting 35 billion to CVS Health (Drug contract). Cigna fully anticipates the process to cause headwinds for the first year, so luckily, for FY23, we will not have to account for this in our DCF model. But the tailwind impact for Cigna will come in after 2024.
This contract entails a multi-year period with a low impact on any given year in this period range. Gill, an analyst, argued the company had expected this at last year's analyst day. Whether CVS Health has anticipated this or not in the guidance is disputable. In this article, though, I argued that the impact of this news, even as it came true, is minimal.
3) Abortion pill Mifepristone legality questioned; pressed by senators to ensure
Mifepristone was approved more than 20 years ago. This came concurrently with the news of abortion being firmly rejected by the US community. The lawsuit has not yet prevailed as of current status.
Risk entailed
On the contrary, if mifepristone is successfully attacked, it could open the possibility of litigation against other drugs.
4) CVS is in a 6M deal for drug overcharging claims in Massachusetts's
CVS will pay 6M for overcharging some prescriptions tied to worker compensation. This is of minimal impact, and I will ignore it in this DCF calculation.
5) CVS Health and Walgreen pay 4.9 billion each for Oploid Settlements
Years of litigation over overdose has been linked to more than 500,000 deaths, inevitably leading to a controversial company. Tentatively, CVS would pay this amount over a decade, leading to a projection of 490m of income per year.
CVS merger acquisitions
Envisioned Value-Based Care Platform
Oak Street Health Acquisition
In May, it completed the acquisition of a primary care company, Oak Street Health, with an offer price tag of $39 per share based on an enterprise value of ~10.6 Billion. Although overpaying for the acquisition, this is deemed of strategic vertical integration value, benefiting the company in the long term. Acquiring Oak Street Health may also surge CVS/Aetna’s MA star ratings by enhancing member recruitment and retention.
Nonetheless, Oak Street Health does not anticipate new clinics to breakeven on contribution margin until Year 3 of operations
So how did Oak Street pay upfront for the costs? It borrowed five billion and funded the remaining 5 billion in cash and fluid resources, amassing 10 billion for the quest.
Signify Health Acquisition
CVS Health issued senior notes to help fund its approximate 8 billion acquisition of Signify Health. Revised Guidance
Despite lowering its adjusted guidance (FY2023), it was only reduced by approximately 2.5% EPS from $8.70- $8.90 to $8.50 - $8.70. This is a moderately lowered guidance from inference as CVS Health had already plunged approximately 35% from the 52 weeks high.
Discounted Cash Flow Analysis based on every input (Acquisitions impact, news impact, EPS guidance) thus far
Conclusively, I derived a DCF forward cash flow with these 5 constructed premises input into the DCF 1) 1 billion operating margins in FY2024 impacted by the star-downgrading
2) 7 billion of Revenue impacted due to the severance of CMS by Centene annually for the next five years
3) Oak Street Health adding on 5 billion of debts (WACC) and reduction of 5 billion in cash (affecting Net debt)
4) Signify health, adding on 8 billion of distressed debt in liabilities and WACC
5) Ensuring FY 2023 hits the sweet spot for the target EPS set by management guidance.
Overall, with the terminal growth at -1% since this is a matured company, I derived a target price value of 107.23 with a 20% Margin of Safety as defined by Warren Buffet himself. This depicts the stock is approximately 35% undervalued.
Conclusion
CVS Health has been heavily bogged down by the adverse news event since October 2022, but we may safely infer that these events have not heavily impacted financials. Subsequently, a DCF model also corroborates this evidence of a firm target price. This is not investment advice but only for entertainment purposes. Please subscribe to the blog for free for the latest updates! Disclaimer: This website is not financial advice and is merely for entertainment and reading purposes.
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