Is It Too Late to Buy CVS Health Stock for the High-Yield Dividend?

Key Takeaways:

• CVS Health shares surged 46.7% after strong earnings.
• Adjusted earnings beat expectations by 29%.
• The stock offers a 4% dividend yield, appealing to investors.
• Regulatory scrutiny and legal challenges pose significant risks.
• Loss of key contracts impacts revenue in the Health Services segment.

A Surge in CVS Health Shares

After underperforming throughout 2024, shares of CVS Health have surged, climbing 46.7% from the end of 2024 through February 14. The stock’s significant gains followed an encouraging fourth-quarter earnings report released on February 12.

Impressive Earnings and Dividend Appeal

Adjusted earnings reached $1.19 per share, exceeding Wall Street analysts’ average estimates by 29%. This strong performance contributes to a generous 4% dividend yield at recent prices, making CVS Health an attractive option for income-seeking investors. Despite pausing annual dividend increases for a few years to support the Aetna acquisition, the company has raised its dividend payout by 90% over the past decade.

The Strength of an Integrated Model

CVS Health’s operations extend beyond its well-known retail pharmacies. The company also runs a leading pharmacy benefits management (PBM) business and owns Aetna, the medical insurance giant. By bringing these entities under one roof, CVS Health gains scale-related cost advantages, enabling it to generate relatively reliable profits.

Rising Healthcare Costs and Their Impact

Last year, the stock faced challenges as higher-than-expected utilization by Aetna members reduced profits. Aetna’s ratio of benefit costs to premiums received jumped to 92.5% from a healthy 84.2% in 2019. With rising healthcare expenses, CVS Health plans to adjust by increasing premiums. As a leading employer of healthcare providers, the company wields more control over these costs than smaller competitors.

Regulatory Scrutiny and Legal Battles

In September, the Federal Trade Commission (FTC) sued CVS Health, alleging that its PBM practices inflated drug prices at the expense of vulnerable patients. The Health Services segment, housing the PBM operations, accounts for over 60% of the company’s total adjusted operating income. This lawsuit introduces a significant risk factor for the company’s most profitable division.

Loss of Key Contracts

In 2023, Blue Shield of California replaced CVS Health’s PBM services by partnering with Amazon Pharmacy and Mark Cuban’s Cost Plus Drugs. This shift contributed to declining revenue and operating income in the Health Services segment in 2024. The loss highlights a vulnerability as clients seek alternative solutions.

Ongoing Industry Challenges

California may not be the last to scrutinize CVS Health’s PBM business. Oklahoma initiated new enforcement procedures against PBMs in 2023, with the first complaint accusing CVS Health of under-reimbursing pharmacies statewide. These regulatory pressures suggest potential for further financial impact.

Optimism for Future Earnings

Despite these hurdles, management anticipates adjusted earnings for 2025 to range between $5.75 and $6 per share. This projection is sufficient to maintain the annual dividend of $2.66 per share and reduce debt. By implementing cost controls and raising premiums, Aetna aims to lower its medical-benefit ratio, potentially leading to significant dividend increases in the coming years.

Investor Considerations

In the recent earnings report, new CEO David Joyner emphasized the company’s integrated model, indicating a commitment to its current structure. While the integrated approach has driven profits, the evolving legal landscape presents challenges that could affect future performance.

Conclusion

For investors, CVS Health’s high-yield dividend and strong earnings may seem enticing. However, regulatory scrutiny and declining revenues in key segments introduce uncertainty. It may be prudent to monitor the company’s responses to these challenges before making investment decisions.