Should CVS Shares Be Preferred Over UNH Shares in Investment?
Should CVS Shares Be Preferred Over UNH Shares in Investment?
Health insurance companies have been under scrutiny recently following the shooting of Brian Thompson, CEO of the medical insurance division of UNH. Adding to investor concerns, a news report suggested a bipartisan group of lawmakers might draft legislation forcing insurance firms to sell off their pharmacy businesses. Donald Trump proposed eliminating intermediaries in the pharmaceutical supply chain, which drives up drug prices. This proposal seemingly targets pharmacy benefit managers (PBMs), who negotiate drug prices between drug manufacturers, insurance companies, and pharmacies. (John Tozzi, 'Middleman' Remark Sinks CVS, UnitedHealth, Cigna Shares, Bloomberg, Dec 16, 2024)
CVS Health stock (NYSE: CVS) plummeted 17% in a week, while UNH Group stock (NYSE: UNH) decreased 11%. Out of the two, we consider CVS stock to be a better investment option at the moment. CVS stock has a 7.3x trailing adjusted earnings multiple compared to UNH stock's 18.4x. Although UNH has superior revenue growth and profitability, the valuation gap between the two should eventually narrow in favor of CVS.
Here, we discuss why we favor CVS over UNH by comparing key factors such as historical revenue growth, returns, and valuation. Alternatively, if you seek higher returns with a smoother ride than an individual stock, consider the High-Quality portfolio, which has outperformed the S&P, delivering returns greater than 91% since its inception.
UNH’s revenue growth has been slightly stronger than CVS
CVS has seen its revenue increase an average of 10% a year, from $269 billion in 2020 to $358 billion in 2023. Conversely, UnitedHealth's 13% average revenue growth rate, from $256 billion to $368 billion during this period, has been relatively more robust.
CVS's revenue growth was driven by heightened demand for COVID-19 testing and vaccination services during the pandemic in 2020 and 2021. However, since vaccine demand has decreased, this trend has reversed. The company's healthcare benefits segment, on the positive side, showed a substantial 40% revenue surge between 2020 and 2023, with improvements in both Medicare and Commercial plans. This was primarily due to an increase in total medical membership, currently at 27.1 million, versus 23.4 million in 2020. This upward trend is expected to persist due to the aging U.S. population. Recently, the company's pharmacy and consumer wellness business has been performing well, boosted by an increase in prescription volume and pharmacy drug mix.
UnitedHealth's revenue growth over the past few years has primarily been fueled by the growing demand for its OptumHealth business, which delivers healthcare services through local medical groups. For instance, OptumHealth's revenue rose 67% between 2020 and 2023, compared to a 44% increase in revenue for the company as a whole. The strong growth in the Optum Health business can be attributed to an increase in the number of patients served under the company's value-based arrangements, including at-home services. Besides, its pharmacy benefit management segment, OptumRx, and insurance business have been doing well, with the overall rise in Medicare membership benefiting its operations.
We anticipate UnitedHealth to continue seeing slightly better revenue growth due to its OptumHealth business heading forward.
Furthermore, UNH is more profitable
CVS’s operating margin decreased from 5.2% in 2020 to 4.1% in 2023, while UnitedHealth's operating margin declined from 8.2% to 7.7% during this period. For the last twelve months, UNH's operating margin of 7.0% is superior to 2.9% for CVS.
Both companies have experienced diminished margins lately due to increasing medical costs. CVS saw its medical benefits ratio climb to 91.7% during the nine-month period ending September 2024, compared to 80.9% in 2020. Similarly, this metric increased from 79.2% to 84.9% for UNH over the same period. In the near term, the medical benefits ratio for both companies is expected to remain elevated due to the aging U.S. population and rising overall health-related expenses.
Conclusively, UNH stock holds a stronger financial standing
Concerning financial risk, UNH has an advantage over CVS. Its 17% debt-to-equity ratio is much lower than CVS's 141%. Moreover, UNH has a higher cash-to-asset ratio of 12%, compared to 4% for CVS. This indicates that UNH has a better debt situation and more financial buffer. CVS's high debt-to-equity ratio can partly be attributed to its stock's steep decline since early 2022.
CVS shares have dipped by 15% from their early January 2021 price of $60, now hovering around $50. On the other hand, UNH shares have seen a significant increase, rising from $330 to around $520, a 60% boost. The performance of these stocks, however, has been anything but steady. CVS posted returns of 55% in 2021, only to slip to -8% in 2022 and further to -13% in 2023. UNH, meanwhile, recorded returns of 45%, 7%, and 1% respectively in the same years. In contrast, the S&P 500 recorded returns of 27%, -19%, and 24% respectively, implying that both CVS and UNH underperformed the S&P 500 in 2023.
Consistently surpassing the S&P 500, especially during challenging times, has proven to be quite a challenge for individual stocks, even for heavyweights in the Health Care sector like MRK, PFE, and JNJ, and tech giants like GOOG, TSLA, and MSFT. In contrast, the Trefis High Quality Portfolio, featuring a mix of 30 stocks, has outperformed the S&P 500 every year over the same period.
The verdict - CVS in the lead?
UNH has shown stronger revenue growth, higher profitability, and a stronger financial position. Nonetheless, CVS looks more appealing based on valuation. At its current price of approximately $47, CVS stock is trading at 7.3x its trailing adjusted earnings per share of $6.36, which is lower than its average P/E ratio of 9.8x over the past three years.
In comparison, UNH stock, currently priced at $500, is trading at 18.4x its trailing adjusted earnings per share of $27.02, a figure higher than its three-year average P/E ratio of 23.1x. The potential impact of PBM legislation, which contributes significantly to the revenue of both companies, increases the probability of a fall in the valuation multiples for both stocks. Given this scenario, the valuation gap between the two should narrow as CVS's profitability improves. CVS is currently undergoing restructuring strategies aimed at boosting efficiency and reducing costs. Our estimate indicates a potential CVS Health valuation of $66 per share, representing a nearly 40% increase, and a UnitedHealth Group valuation of $606 per share, marking an over 20% increase from the current levels.
CVS might surpass UNH in the coming three years, but it's worthwhile to examine how CVS's peers perform on critical aspects. To do this, visit the 'Peer Comparisons' section. Discover further comparisons for companies across various industries through the 'Peer Comparisons' section.
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- The news report suggested a potential legislation that could force insurance firms like UnitedHealth (UNH) to sell off their pharmacy businesses, which could impact their stock prices.
- Despite UNH's stronger revenue growth and profitability, the valuation gap between UNH and CVS Health (CVS) should eventually narrow in favor of CVS, according to the analysis.
- Trump's proposal to eliminate intermediaries in the pharmaceutical supply chain could target pharmacy benefit managers (PBMs), including companies like CVS and UNH, which negotiate drug prices.
- The potential impact of PBM legislation on the revenue and valuation multiples of CVS and UNH increases the likelihood of the valuation gap between the two narrowing, as CVS is currently undergoing restructuring strategies.