(Bloomberg) -- After years of debt-fueled deals, share buybacks, rich dividends and stagnant earnings, CVS Health Corp. is slouching toward the brink of junk credit ratings, forcing the company to focus on fixing its balance sheet.
Moody’s Ratings is looking at lowering the company’s grades by one notch in the coming months, a review that could bring CVS to just a step above high-yield status. S&P Global Ratings has signaled that a downgrade to the edge of high-grade is possible over about the next two years. The company had about $80 billion of long-term debt, including leases, as of June 30.
Any ratings cuts could boost CVS’s borrowing costs at a time when the health care company can scarcely afford it: its profits are under pressure and its debt levels have been climbing relative to its income. Wall Street analysts expect CVS this year to deliver its lowest adjusted earnings per share since 2017. The company is set to report results Nov. 6.
New Chief Executive Officer David Joyner is crafting a turnaround plan, forcing more hard choices after the company pulled its 2024 earnings guidance on soaring medical costs. He inherited the fallout from years of decisions that prioritized short-term stock gains at the expense of bondholders, as CVS transformed itself from a drugstore chain into a health-care conglomerate.
Activist investors at Glenview Capital are agitating for changes. They’ve helped push out Karen Lynch as CEO, and are seeking shifts to the board as well.
“Management’s credibility has eroded,” said Jean-Yves Coupin, Bloomberg Intelligence credit analyst, in an interview. “They haven’t been able to forecast the business’s profitability.”
As the company tries to revamp itself, it’s becoming less aggressive with its spending. CVS said in May that it didn’t plan to buy back more shares this year. And S&P said in August that it expects the company to avoid more large-scale acquisitions this year, and to focus on cutting its borrowings in the next year or two. The bond grader changed the company’s outlook to negative at the time.
CVS’s chief financial officer, Thomas Cowhey, said in August that the company is committed to maintaining its current high-grade ratings. A representative for CVS declined to comment for this story.
Big Spender
CVS, which operates the nation’s largest US retail pharmacy chain, has spent more than $120 billion over than past two decades to expand in healthcare. It’s bought and built clinics, acquired one of the biggest health insurers in the US, and delved deeper into providing prescription drug benefits for employers and health plans. Retail pharmacies only provided about a third of the company’s revenue last year.
The company’s recent troubles stem from the Aetna insurance unit, which it bought in a 2018 deal for about $70 billion. Medical costs are growing faster than premiums in its Medicare Advantage health plans, just as the US government tightens payments to those insurance programs for the elderly in a move that’s squeezed insurers across the industry.
Moody’s is also reviewing Aetna’s creditworthiness. While that entity doesn’t issue new bonds, it has outstanding debt. The ratings of Aetna and CVS are likely to remain aligned, according to Moody’s.
CVS isn’t alone in suffering now. Drugstore rival Walgreens Boots Alliance Inc. lost its investment-grade rating earlier this year as its large debt load strained its business. It borrowed $750 million in the high-yield market for the first time in August, with an 8.125% coupon, much more than blue-chip borrowers typically pay.
Credit Rating
CVS’s debt load rose to 3.3 times its earnings before interest, taxes, depreciation and amortization, a closely tracked measure, at the end of June 2023, up from 2.8 times in mid-2022, according to BI data. Moody’s expects that measure to hit 5 times by the end of the year, far above the level for comparable investment-grade bond issuers.
“You could argue that it’s very high for investment-grade and it’s very much in crossover territory with the BB rating category,” BI’s Coupin said, referring to the highest tier of speculative grade.
The company’s bonds have underperformed the health care sector this year. Meanwhile, interest expense increased $46 million, or 6.7%, to $732 million in the three months ended June 30, 2024, primarily driven by long-term debt issued a year earlier to fund acquisitions and long-term debt issued in May.
--With assistance from John Tozzi.
©2024 Bloomberg L.P.