Motley Fool Hidden Gems Investing - CVS Gets an Activist Check-Up

Episode Date: September 30, 2024

Rates going down are good for homebuyers and car shoppers, right? And after five flat years, can CVS get back on track?   (00:19) Seth Jayson and Dylan Lewis discuss: - Why CVS has activists sniffing around, and how getting the insurance operations right could get the company and the stock back in motion.  - How interest rates are affecting the housing and auto markets, and other updates from KB Homes and CarMax.  (15:08) Jason Moser and Mary Long for a look at Uber, and its quest to become the everything app. Companies discussed: CVS, KBH, KMX Host: Dylan Lewis Guests: Seth Jayson, Mary Long, Jason Moser Producer: Ricky Mulvey Engineers: Tim Sparks, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

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seth thanks for joining me yep uh we've got another activist in the wings and we are catching up on housing and car market data and earnings reports uh seth as we talk here today leadership at CVS has some visitors from Glenview Capital. The hedge fund reportedly has built up a decent stake in CVS and has some ideas for the company's management team. It sounds an awful lot like we might be looking at another activist investor here. Yeah, and it's one of those stories where we get this big headline, and I guess it's the Wall Street Journal, which is then quoted all over the place. You look in, there's no details of any kind. What they might want, what would you do to CVS. And so I haven't looked at CVS as a company for a while. So it was fun to dig in a

little and see kind of what an interesting mess it is, especially for me this weekend, because I had a couple of very interesting CVS experiences as a consumer regarding, you know, the front of the store, which is one of the problems they're having, right? So the front of the store is the like non-pharmacy stuff, right? It's the chips and all of that kind of stuff. And I guess maybe the medical braces that i had such a weird experience with them they had something in there it was 28 bucks but with the app it was like 18 and i said can i just get it for 18 and they said no no we can't do that and i didn't i was like i'll just order it on the app then and pick it up uh in 10 minutes um it just gives you to me it's telling it gives you an example of kind

of the work they have to do in many places at cvs but if you look at the last earnings report uh the front of the store while the sales haven't been great there um the real problem for them is insurance at least in terms of earnings now they're growing revenues in the insurance side of their business folks might not know that they on etna and are one of the bigger insurers in the country as part of this um but the costs in the insurance part of the business are not playing nice if you're a shareholder anyway. And so most of that these days appears to be simple things like not charging enough to be able to cover what you have to pay out, the ratio, but also just specifically Medicaid. The state payout hasn't been matching what they've been pricing. And so

that's been the biggest problem. Yeah. And I think a lot of people had high hopes for the insurance portion of that business. I mean, they had acquired Aetna back in 2018. The current CEO of CVS Karen Lynch came over as part of that acquisition. And I think people had assumed there was going to be a lot of expertise and maybe some more kind of industry defining elements of that business for them that has not materialized. As you mentioned that the costs have been higher. Some of that has also just been the trends of people delayed a lot of medical procedures and are now getting a lot of those fulfilled. Yeah. And so they say, we're going to do better this year. We're going to price better. We got a lot of Medicare coming in, which will be better. And if you read through

the call. They fired the dude who was in charge of insurance. The CEO sort of took over and then put her chief strategy officer in charge of operations at insurance. So they definitely are kind of doing a full court press on getting it right. But, you know, in the meantime, kind of the good news is they have, CVS is almost divisible into thirds, right? You've got like pharmacy in the back where you and I get our pills and so forth. And front of store, the chips and milk and that. That's kind of about a third. And then insurance is about a third. And then pharmacy benefit management, where they manage pharmacy benefits for others and provide some other healthcare services. That's like 40% actually. So the other two businesses are doing

okay. If you look at the financials, the story's not so bad. Their interest coverage has dwindled a little, but it's still four. This to me, the value shop should be sniffing around this. And I guess that's what we see with activists coming in. You mentioned that it wasn't a company you'd looked at for a little while and you'd be forgiven for that. I mean, the company stock is essentially flat over the last five years.

Yeah, it's just boring, right? What's AI about this? Come on. Nothing, not yet at least. And, you know, I mean, shares are down this year. I think a reflection of what we're seeing with the costs on the insurance side. This is not the only time they've added activists

in the mix and interested. We've seen Satcham Head Capital built a stake up earlier this year. starboard value built up a stake before the pandemic. So activists have been sniffing around here for a little bit. What would you want to see to feel like the ship has been righted here? Honestly, if I'm looking at it from a value standpoint and taking initial position, I may have seen enough just in the last call. People kind of hate it, but they seem to have made some big moves. They say, hey, in terms of the management of that section, and then they say,

uh, you know, we're working on that. And also our pricing should be better this year. We think we're doing better with that. So if, you know, you're always taking a risk with value, they've have, should have decent free cashflow if they can get things back where they were a couple years ago. Uh, so in the meantime, if you're somebody who looks at cheap companies, this one looks okay to me. And, you know, they've got all these locations are closing under performing ones. I honestly, by the time I'd gotten done with this today, I said, geez, I might, I might take a small position in this because I haven't played the value game for a while. And there are some advantages to this company.

I mean, it's hard to just buy real estate and put up a competing drugstore. It's obviously not impossible. There's plenty of competition. But, you know, I don't know, how many million bucks do you have to spend to open a drugstore? Not a lot of companies want to roll into that, especially when the existing ones are suffering, right? Yeah. All right. We also had two company updates that kind of flew under the radar last week that I want

to pull forward this week because it gives us a chance to catch up a little bit on the interest rate game. We got KB Homes and CarMax. Why don't we start out with KB Homes? The shortage in the housing market, Seth, is, I think, fairly well documented at this point. That seems to be showing up in the numbers for KB. So KB, the stock kind of sold off, I guess, the old story, decent decent performance, but the guidance wasn't outstanding, right? And so if you look at the numbers, the revenue was $1.75 billion. That beat the estimates by a little bit. And they just missed on EPS. But if you look at what they're doing, they actually are selling through quite a few homes. They're doing a better job getting the homes done in a shorter time. And they think

that by next year, they'll be back to about the three months that is kind of typical from selling the thing, getting it completed. And interest rates should help here. Now, with new home sellers and builders, there's always a question of are interest rates going to help existing home sales more or are they going to help the home builders more? And at this point in time, I mean, I've got colleagues who are saying like, I think the home builders are going to be in trouble because the lower interest rates will make it easier for existing homes to go. And I can see that argument, but I don't believe that is what is going to play out because especially someone like KB, which is a little bit on the lower end of new home pricing,

I think the median new home in the US now is somewhere just under like 480,000. Somewhere in there, KB's is somewhere like 510,000. So they're kind of at the lower end of that. and a lot of existing homes cost a lot more than that uh and that market really hasn't kind of come back so existing home sales in the u.s generally outpace new home sales by by something like five to one uh you know on an annualized rate and i think that there are so many people looking for homes who've been holding off that that the lower rates should help quite a bit both existing home sales and somebody like KB. I ran a little mortgage comparison just to take a look. I haven't taken out a mortgage for so long, I didn't know where the rates were. And so not too long

ago, we were at like 7.5% for 30-year mortgages. And on an average KB home, if you paid 20% down, you'd have been looking at $2,900 a month in the payment. And that's before anything like taxes or escrow. That's just the principal and interest. You drop that to 6.1%, kind of where we are today, and you're looking at $2,400 a month. So you're almost a $500 savings. And then if you bring that down in a few months, say you think we'll be at 5.5% for those mortgages, you're down to about $2,300 a month. So I mean, that's a big difference for homebuyers. And I think we're going to see movement, both at home builders like KB and in existing home sales if the rates continue to go down. To that point, Seth, CEO Jeffrey Mesger said, as rates moderated in August, our net

orders improved. We're encouraged by this strengthening in demand for our affordably priced homes and the ongoing positive trend we are experiencing so far in our 2024 fourth quarter. So it seems like the company is seeing a lot of what you are also looking for with this business. What's amazing to me is in the quote unquote tough rate environment we've been in over the last 12 months, KB Homes is up 86% for shareholders. So it's been performing incredibly well while the climate has been difficult. Yeah.

And I own a couple of home builders. I have recommendations of a couple of them in one of our services. And almost every single one I look at is really near an all time high. And KB collapsed a little after this, but it wasn't very much. They're still very close to an all-time high. I think they were at like $91 a share, and now it's $85 or something like that. I mean, they're still very close. And something like, I think, 11 times earnings for KB these days in a long-term average.

Homebuilder earnings multiples are always like five or seven or something, right? And so they're above that, which always makes you wonder how risky things are, except that we all know that so many Americans are looking for a home and haven't been able to buy one that the demand should still be there. Unless we see a recession, I think the demand is going to support home selling across the board. I think builders are going to do great and existing sales are going to do great. All right. I want to get your take on how the rate environment plays into what we see with autos because there's a lot of sensitivity there as well when it comes to the financing environment. We had earnings from CarMax last week as well.

Wanted to pull those forward. It looked like a pretty decent report. I think top line came in a little ahead of expectations. What did you make of the results? CarMax is another one of those companies that I think makes sense to look at as a bellwether, not only for kind of its particular industry, but sort of for consumers as a whole. And again, that's because we think about new stuff a lot right we're what is what is ford selling what is you know chevy selling what's tesla selling but again used cars sell out sell uh new cars by about three to one in the united states and so um that's a huge market and carmax is one of the biggest players in that market and uh revenues there were flat but uh unit sales were up about five percent and that you know for

a lot of businesses that would mean oh well your your prices are going down you're not making as much money sure for carmax it does mean prices were down but carmax in general sort of makes the same kind of couple thousand bucks per car even when those prices come down so for carmax it really is sort of a volume game and it's actually a little bit better news if prices are trending down i think are we far enough away from the pandemic car panic that we forget that used car prices went insane yeah they were totally upside down yeah it was just nuts nobody could find any kind of cars right because the the car companies all thought no one's going to buy a car right and so they told other suppliers cancel everything right and so then what everyone said

hey we want to buy cars they didn't have parts you remember that mess and then used cars went nuts that's still kind of uh unraveling uh carmax noted that uh their selling prices have dropped it's almost two years uh straight now seven quarters in a row i think comes out to almost two years and i'm willing to bet we'll get to two years and but we're still i think we're still in like you know 20 some thousand dollar range for their average used car where it was like before the pandemic slightly before it's about 19 um so i think again the used or the interest rate drops should help with this now buying a car is not nearly the the leap of course that buying a house is the the loans are shorter and the amounts are a lot smaller uh but it still does help and one of

the pressures on CarMax's earnings this quarter, as opposed to the top line revenue, was having to take bigger reserves in the lending units to kind of reflect the belief that maybe consumers will have a little more trouble paying off their loans coming up. But if we do see some trickle down in the interest rates for car loans, then that should be good news for CarMax the same way is probably going to be good news for homebuyers. I feel like listeners are probably used to hearing us talk about that when it came to a lot of the banks over the last year or so, looking at their loan loss provisions.

One thing that I think would be kind of interesting to be checking in on with this business is, as we see rates come down, does that create a little bit of upside for average selling price? Because I think a lot of folks who have been cash-strapped have probably been looking for cheaper vehicles just because the financing environment has been so tough for them. yeah i wonder i i don't know there's probably good uh good research out there but i feel like

people know what a car might be worth more easily than they know what a house might be worth i think there's there's more transparency in the auto market than the housing you can comparison shop more easily similar yeah houses are never comparable and so i think for cars again since the the amounts are smaller the time periods are smaller and people can comparison shop more easily I don't think that the prices should nudge up, but you know, that's why we get those quarterly reports. We'll be able to figure it out in six months. We'll be keeping tabs. Seth, Jason, thanks for joining me. Thank you. Coming up, Jason Moser joins Mary Long for a look at Uber and its quest to become the everything app.

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Let your morning change you. Discover Coffee Plus on Nespresso.com. JMO, about seven months ago, Uber reported over a billion dollars in annual operating profits. CEO Kasha Shahi called it an inflection point for the company. A billion bucks is a good amount of cash, but why was this such a big deal? Well, you're right. That is a big amount of cash. It's wonderful to see the company headed in this direction.

You know, Uber is a company that I recommended back in June of 2022 to members of our NextGen SuperCycle service. and you know the idea was just basically listen i mean uber is is it's everywhere right we we all use it and there's just a ton of potential there and thankfully uh the stock has done well there was a very glass half empty view on the company at that point and i think it's in regard to that profitability first and foremost and that's why i think it is such a big deal um and thankfully the company's performed very well since then but i mean kasra shari even said in the call like he said that the reason why this was so important was because it proved that the business can continue to generate strong, profitable growth at scale. And that was the ultimate idea, right? I

mean, we've got this tremendous service, but how profitable can it be? And now we've seen a point where Uber has gotten to where it can be consistently and reliably profitable. And that, I think, is even taking into consideration, they have this investment portfolio that quarter in quarter out, that sort of ebbs and flows, right? They realize the net gains or the net losses on that investment portfolio that they have, and that impacts that earnings number. But all in all, the core business itself continues to grow and succeed. And to his point, showing that this business can generate strong, profitable growth at scale, I think it's a big deal. Uber, since its inception, Uber has been a ride-sharing company, but it's also always had

ambitions far beyond that. There was a moment, and I feel like talk about this has kind of subsided, but we might still be in the moment when the holy grail for apps was to become the everything app. China has this and WeChat and investors kind of wanted to see a company become the same thing here in the States. Musk wants to do it with X. Uber wants to do it with Uber. What is the appeal of an everything app in the first place? Yeah. Well, if you remember at one point, PayPal even had the aspirations of becoming that sort of everything or super app, I think it is what they called it. And I mean, I understand the attraction there, right? I mean, it is, there's a lot of convenience, right? I mean, you're just, you're

going to one place to get everything done, which promotes ease of use. You're very familiar with it and you just know how to go in and get your stuff done. And so, I mean, the idea of having everything under one roof on the surface does seem like a very attractive idea, but that does come with costs. And why do you think it's proven so tough to get this idea of the super app, the everything app, off the ground here in the States? Well, I think in regard to those costs that I mentioned, kind of like investing, right? There are a lot of risks that come with getting everything under one umbrella, right? When you put all of your eggs in one basket, well, what happens if that goes down, right? Then what do you do? And I mean, it also, I think from a company

perspective, I mean, beyond just the consumer perspective, but from a company perspective, it risks that Peter Lynchian term diversification, right? Talking about companies that they're trying to do almost too many things, right? They're doing a bunch of things and they're doing them just okay, as opposed to doing just one thing or a few things really well. And I think, you know, when you see in this market, particularly in the US, we see a lot of invention, a lot of iteration, and it moves at a very fast pace. And so we're already very used to using a lot of different apps for different things, right? We use payment apps for one thing, We use commerce apps for another. We use ride sharing for another. And so, I mean, there is, I would say, probably a cultural dynamic to it as well. But I do think part of that has to do with sort of the sandbox we're in where we just have so many different ways to do so many things in here domestically. That's a tough behavior to shift away from.

I'm going to have us time travel for a minute. In July 2023, Josh Brown wrote a piece outlining why he thought Uber could hit $100 a share within the next two to three years. That's two to three years from 2023. And the idea behind that was all about like, he didn't think that X would become an everything app, but that if anyone could do it, it actually might be Uber. And his large reasoning behind that was Uber already is everywhere. At the time he wrote that, this is interesting. Uber traded at about 50 bucks. Today, it's just shy of $80. I'm going to put price predictions aside and focus more on the how rather than like hitting or not hitting a given number. How do you think Uber gets to where Brown and others might want it to go? Yeah, well, I

liked his points. I read that piece and I do like his points on why he believes Uber could, and I want to stress could because he stressed it as well, could become an everything app as opposed to something like a Twitter or X or whatever else, or even PayPal for that matter. I mean, he noted that Uber, unlike something like a Twitter, has just a big head start in the tech scheme of things, right? I mean, they've kind of been after this for a while, doing what they do very well. They have a huge, huge user base, right? I mean, that's just Uber is something that most of us use at this point.

And it's actually a user base that continues to pay money for that service, whereas something like a Twitter, for example, would be based really solely on advertising until Musk took over and he introduced the subscription side of the business. And then also, you know, that revenue base gives them the opportunity really to spread those costs around and try new things, particularly when those new things are core to what the business already does so well. And so when I think about Uber in its growth, I mean, I think one of the things that sets Uber apart from its competition is its ability to piece together multiple complementary business lines. And that ultimately makes the whole business stronger, right? There's this cross-platform nature of the business, which ultimately leads to lower customer acquisition costs, higher retention rates over time. It allows them to expand relationships and ultimately come up with new things. And so I think you put all of that together, and it gives you an idea of why Uber is doing so well, and it also gives you a vision as to why it could continue to succeed in the future. I would think that the two primary businesses that come to people's minds when they think of Uber are, A, the ride-sharing business, and then food delivery.

But where do its efforts to become an everything app stand now? What other businesses does this company have going on that might not be the first thing that come to people's minds? Yeah, well, I think they're taking a very thoughtful approach to that. And I think that's important because they could fall into that trap

of trying to do everything. And then all of a sudden, they're just doing a lot of stuff and they're just doing it okay. And they're really sticking with their core business of what they do so well. So I like that they're taking a thoughtful approach to that.

And I think a good example can be seen in the freight side of their business. So you mentioned the mobility and the delivery side of the business. And that's what most of us all know Uber for today. There is a freight side of the business right now. And that still is a bit of a question mark. They made an acquisition of TransPlace,

I think it was back in 2021, the end of 2021, paid just a little over $2 billion for that. And even today, you look at freight, freight is still just a drop in the bucket for the business. It's really, it drives just a small part of the top line and really even a smaller part of the bottom line. I mean, that itself is still ultimately unprofitable. But I do kind of wonder if at some point

they won't spin that part of the business off. But generally speaking, I think focusing on those core competencies, right? The mobility and the delivery side and then figuring out ways to build new services around that makes the most sense for Uber. When it comes to competition, again, we think of that ride-sharing business,

that food delivery business. Lyft and DoorDash are obvious competitors, right? But a less obvious competitor might be Amazon. And this was flagged. The Financial Times just a couple of days ago published an article titled, Uber's Next Act, Taking on Amazon. That is a big beast to battle and not the first company that comes to my mind when I think of who Uber's playing against.

You know, the Amazon shopping app has 237 million monthly users. That's compared to Uber's 36 and a half million users. Do you see that as being a realistic playbook there? How exactly does Uber come to compete with the behemoth that is Amazon? Yeah, well, that's always a big question we ask in regard to most businesses these days is how is it Amazon proof or at least Amazon resistant? I think with Uber, I mean, right now, I think it's probably more reasonable to look at Uber as maybe benefiting from Amazon and maybe not Amazon directly, although that could be

part of it. But, you know, what Amazon has done so well over the many, many years we've been talking about it and recommending it here at The Fool, you know, Amazon, I mean, just started out as books and then they kind of went into commerce and then you got this AWS side of the business and all this other stuff that Amazon is doing so well. But ultimately, the core, what Amazon has done so well through time is it's sort of changed the value proposition for consumers where we're less focused or maybe, yeah, maybe less focused on price and more focused on convenience. And I think that convenience word is really important here because ultimately that is something that Uber does very well, right? moving stuff from point A to point B, whether it's people or things. Uber is just very good at logistics and getting things from point A to point B. And so I don't look at Amazon as necessarily a direct competitor to Uber. You know, I mean, they fiddle around with food delivery. Obviously, they have a tremendous logistics side of the business that serves their company very

well. But you could also certainly see Uber benefiting from not only Amazon's success, but also just the consumer focusing more and more on convenience as opposed to price. Another surprise part of the Uber business is advertising, and it's doing pretty well. As of the second quarter of this year, the revenue run rate from Uber's advertising business crossed a billion dollars. Is this a business segment that's worth investors paying more attention to? I think over time it will be. I mean, it really is a small part of the business right now. like you mentioned, I mean, it really, so it's running at a $1 billion annual run rate right now

in advertising is interesting in that it can be very profitable. Now, I mean, we don't look at Uber as an advertising business, but I would also argue that in regard to Uber's app, right, it does seem to fit. It seems to be a bit more native. You know, you go into Uber's app and whether it's delivery or whether it's ride share, I mean, advertising just seems to fit. And so when you look at the $40 billion in revenue that the company is bringing in, I mean, yeah, that $1 billion run rate is just a drop in the bucket. However, you also have to remember that is very high margin revenue. It's something that can have a bigger impact on the bottom line. And so again, when you think about how advertising seems to be such a natural fit, it does make sense that

they're making investments in that side of the business. Jason Moser, always a pleasure talking to you. Thanks for joining us on this one and giving us some insight into Uber and their ambitions to build the everything app. As always, people on the program may own stocks mentioned and The Motley Fool may have formal recommendations for or against, so buy or sell anything based solely on what you hear. I'm Dylan Lewis. Thanks for listening. We'll be back tomorrow.