Don’t Judge CVS Health by Its Stores

A reader of this recent article asked why I thought healthcare juggernaut CVS Health (NYSE: CVS) could be a decent investment, given that his shopping experience at CVS stores is generally awful. While the CVS shopping experience can be inconsistent from store to store, the reality is that CVS's front-of-store retail business is only a small fraction of its total operations. It's not that I think CVS runs a great retail business -- it's that its retail business barely matters in the grand scheme of its operations.

In 2018, CVS Health as a whole booked around $194 billion in revenue. Of that, only $19.1 billion came from its front-of-store operations. So less than 10% of the company's revenue in 2018 came from what that reader would call an awful shopping experience. In addition, retail sales generally carry tight margins, so it would not surprise me to find out that an even smaller portion of the company's profits come from running its retail store operations.

Its front-of-store operations will matter even less in the future

Importantly, CVS Health's reported 2018 operations only included Aetna for the time period after CVS completed its acquisition of that health insurer. That acquisition completed in late November 2018, which means that for most of 2018, its results included its retail stores but did not include that health insurance business. In 2019, Aetna will be included for the full year, making CVS Health's front-of-store retail operations an even smaller part of the company's overall picture.

CVS has a history of deprioritizing its front-of-store operations. As part of its push toward its health focus, for instance, it stopped selling tobacco in all its stores. While that decision helped cement its drive to become a preeminent healthcare company, it cost CVS substantial retail sales. The smaller a portion of its business its retail operation becomes, the easier it is to either ignore it or to continue the trend of making statements with its retail business even when it costs sales.

So how does CVS Health make its money?

The following table shows how CVS Health generated its revenue in 2018. Pharmacy products and services represented the largest share of revenue by a long shot. Importantly for investors looking toward the future, the Aetna health insurance business largely rolled into its "Premiums" line for the portion of the year it was part of the overall company.

Based on Aetna's revenue from the time period when it was a standalone business, there will be somewhere in the neighborhood of another $40 billion or so in that line item for CVS Health in 2019. Holding everything else steady, that acquisition alone will push the front store operations down to around 8% or so of the company's total revenue in 2019.

The biggest chunk of its revenue, however, comes from its pharmacy operations. CVS Health claims to hold around 26% of the entire retail pharmacy market in the United States. It also runs a substantial pharmacy benefit management services business that handled nearly 2 billion prescriptions on behalf of its clients in 2018.

What this means for investors

Ultimately, CVS Health is a pharmacy and a general healthcare services company that also happens to run a relatively small front-of-store retail sales business. Its recent Aetna acquisition simply moves it more in that direction. As a result, potential investors shouldn't focus too heavily on their shopping experience in its stores when considering whether to buy its shares.

With the slump CVS Health's shares have faced recently, that healthcare-focused company can now be purchased for less than eight times its anticipated earnings. With earnings expected to return to decent growth in the not-too-distant future as it digests the Aetna acquisition, patient investors have a legitimate chance of ultimately being rewarded for their risks. In the meantime, CVS Health sports a nearly 3.5% dividend yield, offering investors a decent income stream while they wait.

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Chuck Saletta owns CVS Health bonds. The Motley Fool recommends CVS Health. The Motley Fool has a disclosure policy.