Is CVS a Buy After Earnings?

With CVS Caremark (NYSE:CVS) releasing quarterly financial results and trading at $46.36, is the healthcare company a BUY, a WAIT and SEE, or a STAY AWAY?

Let’s analyze the stock with the relevant sections of our CHEAT SHEET investing framework:

E = Earnings Are Increasing Quarter over Quarter

On Tuesday, the largest integrated pharmacy company in the United States reported earnings for the third quarter. Net income increased 16.7 percent to $1.01 billion (79 cents per share), compared to $868 million (65 cents per share) a year earlier. Adjusted earnings surged 21.4 percent to 85 cents per share, beating the consensus by one penny. The company’s forecast was for earnings of 81 cents to 83 cents per share.

CVS received a boost in the quarter due to the friction between Walgreen (NYSE:WAG) and Express Scripts (NASDAQ:ESRX). Larry Merlo, president and chief executive officer, stated, “We posted strong results across the enterprise, with the Pharmacy Services Segment significantly outpacing our growth expectations. The retail pharmacy business continued to capitalize on the market disruption resulting from the impasse between two of our competitors, and our retention of the prescriptions we gained during that impasse has been strong since their dispute was resolved in mid-September. Given what we have seen to date, we are optimistic that we will exceed our initial retention goal for the fourth quarter and now expect to retain at least 60 percent of the prescriptions gained during the impasse.”

Earnings for CVS have been up the upswing all year. For the second quarter, earnings came in at 81 cents per share, an increase from 65 cents in the first quarter. Furthermore, it has beaten analyst estimates in 7 of the last 8 quarters.

E = Equity to Debt Ratio is Close to Zero

The debt to equity ratio is a measure of a company’s financial leverage. A high ratio generally represents that a company has been aggressive in financing its growth and operations with debt. While this may improve some metrics such as earnings in the short-term, too much debt can have disastrous effects in the longer-term.

Looking at CVS’s financials for its quarter ended September 30, 2012, it has a very strong debt to equity ratio of 0.76. However, adjusting for the company’s stock repurchase program, as seen in Treasury Stock, the debt to equity ratio improves to 0.53. In comparison, Express Scripts and Walgreen have ratios of 1.52 and 0.75, respectively.

In short, debt does not appear to be a concern with CVS. The company’s interest coverage ratio, which details how easily a company can cover its interest obligations, shows that it is only spending about 7.4 percent of its operating profit on net interest expenses. CVS is also able to return value to shareholders through strong revenue and cash flow results. Revenue increased 13.3 percent in the third quarter to a record $30.2 billion, while free cash flow year-to-date totals $4.1 billion.

Merlo explains, “We continue to deliver substantial free cash flow and to return significant value to our shareholders. Between dividends and share repurchases, we have returned more than $4.8 billion to our shareholders year-to-date and we remain highly focused on enhancing shareholder returns.”

Conclusion

The latest financial results from CVS were very positive. Shares jumped more than 2 percent on the news, but ultimately closed 0.54 percent higher. Year-to-date, CVS has gained about 15 percent, outpacing Walgreen’s 3 percent gain.

CVS is trading near all-time highs, so it would not be surprising to see investors take profits in the short-term, but longer-term trends remain intact for the industry. The United States has an aging population, and healthcare will be in focus for many years to come. With more than 7,400 CVS/pharmacy stores, the company is the leading pharmacy benefit manager, serving more than 60 million plan members. Meanwhile, its retail health clinic system is the largest in the nation with around 600 MinuteClinic locations.

Taking into account these components of our CHEAT SHEET framework, we find that CVS is a BUY for investors looking for a specific healthcare play. Others may feel more comfortable investing in an index such as the Health Care Select Sector (NYSE:XLV), which holds health-related names such as Johnson & Johnson (NYSE:JNJ), Pfizer (NYSE:PFE) and UnitedHealth Group (NYSE:UNH).

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