Motley Fool Money - 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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We're checking in on the way rates are hitting home and autos. Mottleyful money starts now. I'm Dylan Lewis, and I'm joined over the airwaves by Motley Fool analyst, Seth, Jason. Seth, thanks for joining me. Yep. We've got another activist in the wings, and we are catching up on housing and car market data and earnings reports. 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 in, I guess it's the Wall Street Journal, which is then quite quoted all over the place. Did you look in there's like 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

the front of the store, which is one of the problems they're having, right? So the front of the store is the 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, we can't do that. And I was like, I'll just order it on the app then and pick it up in 10 minutes. 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, the front of the store while the sales haven't been great there, 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 Aetna and are one of the bigger insurers in the country as part of this. 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's the state pay out has. 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, the cost has been higher. Some of that has also just been the trends of people delayed a lot of. 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, So in the meantime, the kind of the good news is they have, CBS is almost, almost divisible into thirds, right? You've got like pharmacy in the back where you and I get our pills and so forth and in 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've looked at for a little while, and you'd be forgiven for that. I mean, the company, the 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.

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, 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 should have decent free cash flow, if they can get things back where they were a couple years ago. So in the meantime, if you're somebody who looks at cheap companies, this one looks okay to me. And they've got all these locations, they're closing underperforming ones. Honestly, by the time I'd gotten done with this today, I said, geez, 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, 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? 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 Holmes and Karmax. 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 shown up in the numbers for KB. So KB, the stock kind of sold off, I guess, the old story, 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 our 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 U.S. now is somewhere just under like $480,000, somewhere in their KBs 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. And that market really hasn't kind of come back. So existing home sales in the U.S. generally outpaced new home sales by something like five to one, you know, on an annualized rate. And I think that there are so many people looking for homes who've been holding off 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 selling. 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 in 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 will be a 5.5% for those mortgages, you're down to about $2,300 a month. So, I mean, that's a big difference for home buyers. 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 Mezger 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 Holmes 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 bucks or 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 home builder 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. 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 Topline 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 is 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? What is Ford selling? What is, you know, Chevy selling? What's Tesla selling? But again, used cars sell new cars by about three to one in the United States.

And so that's a huge market, and CarMax is one of the biggest players in that market. And revenues there were flat, but unit sales were up about five per year. And that, you know, for a lot of businesses, that would mean, oh, well, 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 in six?

Yeah, they were totally upside down. Yeah, it was just nuts. Nobody could find any kind of cars, right? Because 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 unraveling. CarMax noted that their selling prices have dropped. It's almost two years 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. But we're still, I think we're still in like, you know, a $20-some thousand range for their average used car where it was like before the pandemic. Like before it was about 19.

So I think, again, the used or the interest rate drops should help with this. Now, buying a car is not nearly the leap, of course, that buying a house is. The loans are shorter and the amounts are a lot smaller. But it still does help. 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 unit 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 it is probably going to be good news for homebuyers. I feel like listeners 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 it 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's been so tough for them. Yeah, I wonder. I don't know. There's probably good.

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 more transparency in the auto market than the housing market. You can comparison shop more easily. The comps are similar. Yeah, houses are never comparable. And so I think for cars, again, since the amounts are smaller, the time periods are smaller and people can comparison shop more easily, I don't think 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 Act. The old adage goes, it isn't what you say, it's how you say it, because to truly make an impact, you need to set an example and take the lead. You have to adapt to whatever comes your way. When you're that driven, you drive an equally determined vehicle, the range rover,

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The Range Rover event is on now. Explore enhance offers at Rangerover.com. J-Mo, about seven months ago, Uber reported over a billion dollars in annual operating profits. CEO, Kashashahi, 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, it's everywhere, right? We all use it.

And there's just a ton of potential there. And thankfully, 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. And thankfully, the companies performed very well since then. But, I mean, Kastra 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 and 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 in 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, 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. 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 U.S., 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 a 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.

Yeah. Could become an everything app as opposed to something like a Twitter or X or, you know, whatever else, or even PayPal for that matter. I mean, he noted that it, 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 Must Hook 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 like food delivery. Yeah.

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'd 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 had an acquisition. 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 spend 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. Lift and DoorDash are obvious competitors, right? But a less obvious competitor might be Amazon. And this was flagged the Financial Times just a couple 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 what Amazon has done so well over many, many years we've been talking about it and in recommending it here at the Fool, you know, Amazon 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's 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 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. And 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 know, you also have to remember that is very high margin revenue. It's something that to 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 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 out.

As always, people on the program may own stocks mentioned and the Motley Fool may have formal recommendations for or against. So buy or not anything based solely on what you hear. I'm Dylan Lewis. Thanks for listening. We'll be back tomorrow.