Sold Cash Secured Put + Investment Thesis – CVS Health Corporation (CVS) – $66.50 strike – DEC 08 Expiration

This is actually the second time recently that I’ve sold a CVS put. The first position was opened on October 16th. I twittered about it, but completely failed to fulfill my promise for an investment thesis:

Once that postion expired worthless, I reopened nearly the same contract ($1 lower strike), for nearly the same return earlier this week:

I finally got a chance to write about it today.

Please visit the core philosophies article on my investment thesis process for a deeper explanation of the components of this article. Additionally you might find my rules for trading options helpful in understanding the parameters of the trade.

I have updated the portfolio and income tracker pages to reflect this position.

Dividend Cycle

CVS went ex-div on 10/23/17, which was right in the middle of the first contract, so I was unlikely to collect the dividend this quarter. Both contracts exceeded the quarterly dividend amount by ~30%, and were only in force for a month. I would expect the next ex-div date to be in late January, and I expect it to include a healthy increase to the payout. That’s because CVS is a dividend contender sporting 14 consecutive years of dividend increases, and they’ve been at $0.50/share for 4 quarters and are due for a bump.

Investment

# contracts

Strike

Expiration

Total Premium

Days in Force

Annualized Return

Closing Price

Downside Protection

1

$66.50

12/08/17

$64.20

25

14.10%

$71.48

6.97%

The QC (Quantitative Case)

Payout Ratio – EPS, FCF

39.8%, 25.4%

10 Year Revenue CAGR

13.3%

10 Year EPS CAGR (5 Year EPS CAGR)

15.5% (18.13%)

5 Year ave P/E – Current P/E (ttm)

20.0 – 14.4 = +5.6

5 Year ave Yield – Current Yield  

1.5% – 2.9% = -1.4%

10 year mean DGR (dividend growth rate)

27%

Debt/Market Cap

$26.76B / $71.42 (37.5%)

Total Cash

$2.17B

Return on Assets

6.86%

Return on Equity

15.4%

Profit Margin

2.93%

EBITDA/Revenue

$12.65B / $180.79B = 7.0%

Reverse DDM Fair Value DGR at Strike

7%

Assumed DGR (DDM valuation 10% disc.)

7.7% ($87)

DGR Margin of Safety

0.7%

Dividend Cushion Ratio (7.15% DGR)

1.16

Cash from Ops “cushion”

-3.75%

Capex “cushion”

+15.7%

DGR “cushion” (delta)

+4.95%

SPL (Strike Price Logic)

The $66.50 strike price represents a 3% yield (based on the current distribution). It’s really as simple as that. I like that yield level, especially compared to the company’s 5 year average of 1.5%.

As I mentioned earlier, I expect the next quarterly dividend announcement to include a raise. Depending on how big of an increase it is and what happens with the share price, my fair value price assumption and future put contracts will adjust accordingly.

QWaF (Qualitative Warm and Fuzzy)

America’s pill-popping culture and future demographic shifts (ageing population) are working in CVS’ favor. Although they’re primarily a retail pharmacy, they have a number of other business lines like Omnicare and Caremark that are more specialized, sticky forms of revenue.

I was kind of surprised to find that google finance puts them in the consumer staples sector as opposed to healthcare, but whatever.

Their size and ubiquity provide them a unique position of strength to adapt to the changing retail environment for consumer goods and still capitalize on the demographic shift that should drive exponentially increasing healthcare spending in the coming decades

CPR (Cold and Prickly Risks)

AMAZON WILL CONSUME THE ENTIRE PLANET!!!!! CVS IS NEXT!!!

Can Jeff Bezos do to local retail pharmacies the same thing he did to your local neighborhood bookstore? I don’t know…maybe?

But I think management is already making the right moves to anticipate and counteract the so-called “amazon effect”. Also for at least the next 10 years or so, I would expect old people to prefer to go into an actual store and talk to a live pharmacist rather than get their prescriptions via drone.

While that transition occurs the cash flow is healthy and the debt situation (although not perfect) is still reasonably in check.

Sign me up!

 

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