CVS Plans to Close Oak Street Acquisition Early, Adding Another Headwind to Near-Term Profits

Narrow-moat CVS Health CVS announced that the Oak Street acquisition is expected to close earlier than anticipated in first-half 2023 rather than around the end of the year. This change will push Oak Street’s operating losses into CVS’ results earlier than anticipated, which will likely cut into 2023 EPS estimates. Even after considering that and other near-term headwinds in our assumptions, though, we are keeping our $113 fair value estimate for CVS intact and continue to view shares as significantly undervalued.

First, while management has highlighted that its earnings outlook for 2024 (around $9 per share) and 2025 (double-digit growth) already included the negative effects from the Oak Street deal, we suspect that the company’s guidance for 2023 (EPS of $8.70 to $8.90) will be lowered moderately with its May earnings release.

Second, the Centers for Medicare and Medicaid, or CMS, appears to be setting up Medicare Advantage, or MA, to be less attractive relative to traditional Medicare starting in 2024. In October, CMS revealed MA Star rating cuts across the board for the industry. CVS was hit even harder than its peers in those ratings, which may cut into both membership enrollment growth and bonuses shared with caregivers in the near term. Combining that change with recent reimbursement rate notices and risk-related changes for the MA population relative to traditional Medicare, we suspect that the heady MA growth rates experienced in recent years may decelerate and create some risk to the industry’s 2024 growth prospects, in particular.

Third, policy concerns in the pharmacy benefit management, or PBM, business that CVS leads have emerged around transparency and spread-based pricing. Based on previous disclosures by industry players, we suspect the potential changes being explored in Congress may be easily manageable by the top-tier PBMs. However, those changes could cut into the firm’s near-term outlook, depending on the timing and, of course, the actions taken.