Value stocks often deserve the depressed equity valuations they receive. Shrinking long-term demand, strengthening competition, operational blunders, and much more can lead to stocks being cheap for very good reasons.
Still, there are rare cases where these value stocks actually have the ability to deliver meaningful shareholder returns over time. Let's dig into two of those names specifically.
1. CVS Health is strong
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CVS Health (CVS +1.38%) trades at a forward P/E ratio of 10.1. Its brick and mortar pharmacy business has long been under competitive pressure from Amazon, but Bezos has been trying to compete in this space since 2002 with Amazon's failed purchase of Drugstore.com -- and still, CVS is performing well financially.
In CVS's most recent quarter (July to September 2020) revenues rose 3.5% year over year to roughly $47.7 billion. CVS's cash flow from operations jumped 20.3% year over year to roughly $12.3 billion. This strong result prompted the company to raise its cash flow from operations forecast by $1.75 billion for the full fiscal year -- its second straight quarter doing so.
Importantly, CVS's outperformance in cash generation allowed it to comfortably cover its dividend, pay down $4.75 billion in net debt, add over $3.5 billion in cash to its balance sheet, and finally recommit to continued de-levering of its operations to 3x by 2022.
To strengthen the company's somewhat precarious brick-and-mortar pharmacy moat, it has been actively transforming its store footprint into what it calls Health Hubs. These health hubs will have all of the goods consumers have come to count on from a pharmacy, but will offer much more than that.
The hubs will serve as routine medical service centers for common illness treatment, chronic care, and a plethora of other examinations that a company like Amazon cannot just ship to your door like it can with a prescription. The company has enjoyed a significant uptick in store performance for the locations already converted, and will continue to convert more going forward.
To sharpen the company's edge even further, it purchased Aetna -- one of America's largest pharmacy benefits managers -- in 2018. The integration allows CVS to profitably power more savings and convenience for its customers through a more vertically integrated approach -- a win-win for all involved. The current CVS CEO, Larry Merlo, will step down this year and former Aetna President Karen Lynch will take over.
With the company performing so well financially, now is a perfect time for a leadership change and Lynch is a strong candidate to continue fostering CVS Health's success.
2. FedEx is finally delivering
Just like with CVS, FedEx (FDX +0.58%) has struggled for years with the concern that Amazon's entrance into its courier industry would be a death knell. But again, not so fast. While Amazon made up a sizable portion of FedEx's order book at the relationship's peak, it was FedEx's lowest margin business -- the company made very little money on Amazon.
While the break-up with Amazon was not seamless, it allowed FedEx to focus on building a higher quality order book to realize more profits. More recently, the company has announced partnerships with large caps such as Walmart, Target, and Dollar General -- three direct competitors of Amazon that are happy to give their logistics business to a non-competitor like FedEx.
The financials support this encouraging story quite well.
In FedEx's most recent quarter (September to November 2020) revenues jumped 19% and reported operating margin briskly expanded from 3.9% to 7.4% -- both year over year. As a result, FedEx's net income spiked 97% to $1.3 billion. The company long struggled with compressing margins and profits -- that is no longer the case with executives like Rajesh Subramaniam helping guide the company to triumph. Regardless of the strong performance the company trades for just 14.3 times forward earnings.
We should consider that FedEx has been boosted somewhat by the pandemic. E-commerce demand exploded with COVID-19, and FedEx is a beneficiary of that on the business-to-consumer (b2c) side of things.
Still, it does have a large business to business (b2b) segment of operations that was severely hurt by the pandemic and should recover as it ebbs. These b2b fulfillments are generally higher margin for FedEx than e-commerce, meaning it should actually benefit from the world normalizing over time.
Two value stocks with real value
CVS and FedEx both provide shareholders with brighter futures than either's performance or valuation may indicate. For this reason, both are in my portfolio and I think you should consider the two stocks as well.
