Issue #37: A highly profitable dividend-paying healthcare innovator and one of the greatest tech disruptors of the century (so far) 🚨
Unless you spent the last 30 days on an extended spelunking expedition, you probably know that September was not a great month for the stock market.
That’s not a surprise. September has traditionally been a weak month for stocks. This time the concern has been unusually vocal, with some analysts predicting a market plunge on the scale of 2008.
Let’s be clear on one thing: nobody, anywhere, knows what markets will do.
Anyone who claims to know for sure is being dishonest. But while nobody knows there will be a crash, there are legitimate causes for concern.
- We’re in the longest bull run in history: over 9 years. Nothing lasts forever.
- Margin debt is at all-time highs and options trading volume recently exceeded stock trading volume for the first time ever, indicating high levels of risk.
- Stock market holdings are half of all household assets, a 70-year high.
- Social media and “gamified” trading apps are magnifying the FOMO impulse and encouraging increasingly risky trades.
- Rising inflation means that the Fed may have to raise interest rates, shutting off the flow of liquidity that has driven the bull market from the start.
When everybody with the capacity to invest is “all in” and liquidity is reduced, a serious correction, even a crash, is a possibility.
That doesn’t mean it’s time to panic. Let’s look at some realities of crashes.
- A crash is an opportunity. Investors who are holding cash or cash equivalents can scoop up quality companies at a huge discount.
- Crashes aren’t equal. Market gurus may talk about a 20% or 50% or 80% correction, but that doesn’t mean all stocks fall that much. In every past correction, some stocks were barely affected, some took an average loss, and some got slaughtered.
So what can investors do to prepare for the possibility of a correction without panicking and bailing out completely? You may want to consider:
- Holding some cash. If stocks fall hard, it could be an opportunity to pick up high-quality stocks at a discount.
- Watch out for heavily hyped, overbought stocks. These are stocks that have high P/E ratios relative to its sector or relevant index. They tend to fall the hardest when things go south.
- Look into defensive stocks. Stable, profitable companies in recession-resistant sectors like health care and consumer staples typically hold up well in downturns, especially when they pay solid dividends.
Because we’re in uncertain times, we’ll be splitting our coverage, featuring one defensive investment and one more aggressive option. Because we believe in growth, we’ll be looking for defensive stocks that also have growth potential.
Reminder: All investing should be regarded as long term. The value of your investments can go up and down, and you may get back less than you invest. Past performance is no guarantee of future results. If you’re not sure which investments are right for you, please seek out a financial advisor.
Let's get into this week’s report.
- A dominant pharmacy chain that has expanded into an integrated consumer healthcare provider.
- An emerging player linking big data and cloud-based technology in a bid for global domination.
CVS Health Corporation ($CVS)
$84.07 - Share price at the time of writing
- CVS is the largest pharmacy chain in the US, both by the number of outlets and by prescription drug market share.
- The acquisition of Aetna in 2018 moved CVS into a leading position in the health insurance market. The Company is also a leading pharmacy benefit provider.
- CVX has expanded 1100 pharmacies into affordable walk-in primary health care centers, filling a vital healthcare need and creating pharmacy customer flow.
- CVS is a dividend-paying stock in a recession-proof business at an attractive valuation.
What they do:
CVS’s core business is retail pharmacies. CVS has 9600 pharmacy stores and is the nation’s largest pharmacy chain both by the number of outlets and by prescription drug sales. CVS also offers online sales and delivery.
82% of Americans live within 10 miles of a CVS store. 71% live within 5 miles of one.
CVS is a major pharmacy benefit plan provider, with over 105 million members. Their dedicated senior pharmacy care business serves over one million patients.
CVS has an independent group of doctors, pharmacists, and other experts who review and approve the safety and efficacy of all drugs sold by CVS.
CVS Specialty Pharmacy Services provides compounding pharmacy services, mixing specialty medications for patients with specific needs.
CVS operates over 1,100 Minute Clinics, walk-in primary care clinics providing consultation with nurse practitioners and physician assistants. These clinics provide affordable primary care, diagnostic services, vaccinations, and other critical community health services, helping patients get affordable early treatment and avoid expensive hospitalization.
The Aetna acquisition is the basis of the CVS Health Care Benefits division, which is one of the largest health care benefits providers in the country, serving 34 million customers.
The Health Care Benefits division offers health insurance plans directly and through employers. They also offer Medicare Advantage, Medicare PDP, Medicare Supplement, Insured Medicaid Contracts, CHIP, and other government-linked plans.
What we learned from social media patterns:
Here’s a chart of the stock price and social media mentions of CVS over the last 5 months:
The social media mention pattern looks like a health ECG: steady. The price is much the same way. This pattern is consistent with CVS’s identity as a classic “boring stock”. No high tech innovations, no famous CEO, just steady growth and market dominance in an unshakeable recession-proof business.
This is not a controversial stock. It’s not generating passion, greed, or fear. Nobody is diving in out of FOMO. Investors are aware of CVS, but they aren’t excited. That means it’s not overhyped and it’s not overbought.
Notable comments from Reddit:
“Long CVS, very cheap stock. Debt reduction-> dividend increases in a years time will help boost the stock while minute clinic gets rolling. Amazon not a serious threat with synergies from Aetna.”
“I'm long cvs and wba. My thesis for both is that while mail order pharmacy is gaining market share there is always going to be a need for immediate access to medication. You get sick and get a prescription you can't wait a week for cough medicine. Additionally cvs is pushing heavily into their minute clinics /urgent care. Need a flu shot or something basic, cvs can get it to you on demand. Until Amazon develops a nationwide footprint of stores with staff cvs wins.”
💸 Signal: Jeremy Grantham of GMO Asset Holdings has purchased 367,000 shares of $CVS in three separate transactions in 2021.
Why $CVS could be valuable:
CVS is the largest pharmacy chain in the US by prescription drugs market share:
This dominance provides economies of scale and positions the company as a primary competitive force in the industry.
CVS sits at the intersection of multiple industry growth trends. All of these trends share the same underlying drivers: increasing aging of the population and rising demand for primary and preventive healthcare services.
- Overall sales at retail pharmacies and drugstores are expected to grow at a CAGR of 2.7% through 2025.
- The US compounding pharmacies market is expected to show a 5.7% CAGR through 2027.
- The US online pharmacy market is projected to show a 19% CAGR through 2026.
- The US pharmacy benefit management market is expected to grow at a CAGR of 9.2% through 2026.
- The US primary health care market is expected to grow at a CAGR of 4.7% through 2027.
- The US Health insurance market is projected to grow at an average CAGR of 6% through 2027.
CVS is an established leader in all of these markets, allowing it to exploit synergies between them. Each business can refer customers to the others, and the Company as a whole can create incentives for customers of one sector to use the Company’s services in other sectors.
CVS is using its unparalleled community coverage to build a chain of accessible, affordable, integrated health services centers. Filling a largely vacant niche in the healthcare space and transforming the consumer health care landscape.
While most investors associate “innovation” with revolutionary products using advanced technology, the concept goes beyond that. Innovation can also mean rearranging traditional services to deliver them in a more efficient and accessible way. CVS can be considered a healthcare innovator.
CVS has established a consistent growth record in a recession-proof industry, showing solid revenue growth for five consecutive years and beating analyst earnings estimates for four consecutive quarters.
CVS has a 5-year average dividend yield of 2.85% with an entirely sustainable payout ratio of 36.63%, just 20% of free cash flow. Over the last decade, CVS has increased its dividend by an average of 19% a year.
CVS trades at a very appealing valuation. The forward P/E is only 10.56 and the PEG ratio is 1.84. The price/sales ratio is 0.41.
CVS has raised its FY 2021 EPS guidance from a range of $7.56 to $7.68 to a range of $7.70 to $7.80. Revenue guidance is up from a range of $279.2 to $283.7 billion to a range of $280.7 to $285.2 billion.
24 analysts currently cover CVS. 5 rate it “Strong Buy”, 10 say “Buy”, 9 say “Hold”, for a consensus “Buy” recommendation. The average price target is $96.11, 14% above the current price.
What the risks are:
CVS faces intense competition in its core pharmacy business, both from traditional pharmacy chains like Rite Aid and Walgreens and from new online entries like Amazon Pharmacy. CVS will have to fully exploit the synergies among its product lines to maintain its dominant position.
CVS is still carrying substantial debt from the Aetna acquisition. They have paid off $17.6 billion in debt since that transaction, but any significant drop in revenues or earnings could force the Company to choose between debt payments and dividends.
CVS operates in heavily regulated businesses. Compliance failures or any change in regulations or healthcare policies could adversely affect the Company.
A significant portion of CVS revenue comes from programs funded by the federal government. Changes in these programs could affect the Company.
Bottom line: CVS Health is a secure, established operator in a largely recession-proof sector, with steadily growing revenues, earnings and a strong and affordable dividend.
Snowflake Inc. ($SNOW)
$303.72 - Share price at time of writing
- Snowflake provides cloud-based systems for the storage and management of data.
- Snowflake takes an entirely new approach to data management, allowing seamless sharing and data governance without copying or moving files.
- Snowflake’s customer list includes 186 of the Fortune 500. Financial services, healthcare, and other data-intensive businesses have flocked to Snowflake.
- Snowflake revenue grew 124% in the last fiscal year and 174% in the fiscal year before that.
What they do:
Snowflake stores and manages data. Their unique cloud-based management system allows customers to consolidate and control data to drive insights, power applications, and share information.
Snowflake eliminates data silos: collections of data held by one part of an organization that are not easily accessible by other parts.
Large enterprises have traditionally stored data in on-site physical servers, usually with multiple backups. Snowflake moves data to the cloud and separates storage from the computing functions, which allow users to link data from disparate sources using queries.
Snowflake provides a cutting-edge system for data security and governance, allowing organizations to share data with those who need it while controlling unauthorized access.
Snowflake’s system allows global companies to eliminate multiple redundant data stores and share data instantly and seamlessly across hundreds or thousands of units. For example, Snowflake client Western Union consolidated over 30 data stores and reduced data warehousing costs by 50%, saving millions of dollars.
Snowflake’s current focus is on finance, healthcare, advertising, and government clients, all of which generate and manage vast amounts of data. Other data-intensive businesses like shipping, travel, insurance, and many others are jumping on board.
Snowflake customers cover almost every business niche, from AI and machine learning to geospatial analysis and shipping.
Financial services giant Ascenium uses Snowflake to support millions of trades a day for hedge funds, banks, asset managers, and private equity firms. Fast-food restaurant Chipotle uses Snowflake to drive its customer rewards program and provide better service to delivery and pickup customers.
Wherever businesses use data - and that’s almost everywhere - businesses are using Snowflake to manage data.
What we learned from social media discussion:
Snowflake’s social media mentions show continuous moderate interest with a spike surrounding each quarterly report. Interest seems driven primarily by results, not news or stock movements.
The comment content is more interesting than the comment pattern. Comments are almost entirely from short-term options traders who appear to have no idea what the company does and sometimes admit it.
Snowflake is a highly visible company. The Sept. 2020 IPO was the largest software IPO in history. It’s still a poorly understood company. Many investors realize that there’s something revolutionary going on but very few seem clear on what it is.
💸 Signal: Warren Buffet, who is notoriously averse to cutting-edge tech companies, purchased 6.13 million shares of $SNOW at the IPO and has held them since. Tiger Global has purchased 2.48 million shares in 2021.
Why Snowflake could be valuable:
Snowflake assesses its total addressable market is $81 billion. It could be higher. The International Data Corporation estimated that $88 billion was spent on data storage in 2018 and projected growth to $176 billion in 2023.
The data warehousing market was worth $13 billion in 2018 and is expected to reach $30 billion in 2025, a 12% CAGR.
The data storage market is fragmented. Business Warehouse from SAP, the largest player, holds 15% of the market, Apache Hive holds 11%, and Snowflake is third and rising fast at 10%. Snowflake does not have to contend with a dominant established competitor with a majority market share.
Snowflake has accomplished something close to impossible: they have created a service that has significant utility for almost every industry on earth, from the most rarefied technology and financial firms to fast food and shipping. Few (if any) companies have such a broad potential customer base.
Snowflake was launched in 2014. In only seven years of operation, it has gone from 80 customers to over 4900. 116 customers paid Snowflake over $1 million in the past year. The net revenue retention rate, a key measure of customer satisfaction, is an exceptional 169%: the users like the service.
Revenues grew 124% in the last year and 174% in the year before that. Remaining Performance Obligations (services that have been contracted but not yet paid for) are $1.5 billion, almost 3x FY 2020 revenue. That suggests that FY 2021 will also see a high growth rate.
Snowflake has combined two broad-scale megatrends - cloud computing and big data - into a highly usable, customer-friendly solution. All indications are that the customers love it.
Snowflake is not profitable and losses are large, as the company pours money into expanding and perfecting its services. The company is sitting on over $4 billion in IPO-generated cash and can sustain its current burn rate for years without serious concern. Debt is minimal.
Snowflake’s valuation metrics seem wildly exaggerated. The Company trades at 109.5x TTM sales, which would be absurd if it wasn’t showing such extraordinary growth. The Company doesn’t trade on what it is, it trades on the widespread belief that it will become a tech behemoth on the scale of Amazon or Alphabet.
29 analysts currently cover Snowflake, with a consensus rating between “Buy” and “Hold”. The average price target is $324.65, 7% above today’s level.
What the risks are:
Snowflake’s direct competition is fragmented, but public cloud providers like Amazon Web Services, Microsoft Azure, and Google Cloud Platform are rapidly gaining competitive services. Snowflake is compatible with all three and they are often used together, but they could emerge as sophisticated and well-funded competitors.
Snowflake has a limited operating history and its growth rates may not be sustainable. The Company is losing significant amounts of money and may not achieve profitability.
Any data security breach could damage the Company’s reputation and lead to costly litigation.
Snowflake’s business is international, exposing the Company to overlapping and sometimes conflicting regulations and currency rate risks.
Snowflake’s business could be affected by data privacy legislation.
Bottom line: Snowflake is by no means a cheap stock, but the Company has extraordinary potential and could easily become one of the dominant technology firms of the 21st century. It’s currently trading at 44% above its IPO price. If $SNOW fulfills its potential, that may someday be seen as a bargain entry point.