We will continue a theme we have had around our covered call ideas over the past four to six weeks. We are keeping everything mostly defensive given it is hard to divine the direction of a market that lacks conviction.
In that vein, today we are teeing up CVS Health Corp. (CVS) , a stock that has dropped around one-quarter of its value from recent highs and is now offering solid value despite some challenges. Wrapping a covered call strategy around this defensive name adds some downside protection while enhancing its yield. Remember, covered call orders involve buying an equity and simultaneously selling just out of the money call strikes against the new position. Basically, this play should provide a solid return, with little worry even if the market trades sideways.
CVS shares have been under pressure lately on several fronts. With the impacts of the Covid pandemic finally largely ended, Covid-driven treatment, testing and vaccine revenues are falling precipitously for almost every company serving this need. In addition, millions of Americans will soon lose Medicaid coverage with the expiration of key pandemic-era legislation that expanded this program. This is a marginal negative for CVS.
The company has been focused on its $8 billion acquisition of home-healthcare provider Signify Health (SGFY) , which just closed at the end of last month. CVS also announced in early February that it was acquiring Oak Street Health (OSH) in an all-cash deal worth just under $11 billion.
Amid these pressures, the decline since early December has brought CVS stock roughly 25% lower to just under $78.00 a share.
Despite some continued headwinds there is quite a lot to like about the shares. It starts with valuation. Management has mapped out that it sees $8.70 to $8.90 in adjusted earnings per share in 2023, followed by $9 a share in 2024 and $10.00 a share in 2025. The company also expects between $12.5 billion and $13.5 billion in operational cash flow this year.
The stock currently has an approximate market cap of $100 billion after its recent pullback. That leaves CVS trading for around 9x this year's projected earnings per share. Sales growth will likely be slightly below inflation in 2023 reflecting the drop-off in Covid-related revenues but a good portion of the rest of the company's sales streams are relatively inelastic. The shares also yield 3.1% at current levels.
Indeed, CVS's valuation is starting to draw some analyst firm attention. Both Barclays ($100 price target) and Bank of America ($104 price target) reissued their "Buy" ratings at the end of March.
Our CVS Option Strategy
Options around CVS are quite liquid. To establish an initial position in CVS utilizing a covered call strategy, do the following.
Selecting the November $77.50 call strikes, fashion a covered call order with a net debit in the $70.90 to $71.00 a share range (net stock price - option premium).
This strategy provides downside protection of approximately 10% including dividends and approximately the same potential upside even if the stock does nothing over the option duration. Given the usually low beta and defensive nature of this stock, that is an acceptable return, in my view.
