This blog is devoted to helping investors make informed decisions. It will be regularly updated and provide opinions on earnings results. It is not intended to give investment advice and should not be taken as such. Consult your investment advisor.
Sometimes the best thing to do in investing is nothing. In the case of the pharmacy chains CVS (NYSE: CVX) and Walgreen(NYSE: WAG), this policy has been a winning one over the last year.
Their stock prices have risen by 34% and 39.4% respectively in that
period, mixed with short downward moves as investors looked to cash in.
Meanwhile, both companies continue to generate huge amounts of cash
flow, and according to analyst estimates, they're set for double-digit
growth in the near future. The "good news" is that the market marked
down CVS following its results, and this looks like a good entry point
for long-term investors.
CVS’s optical illusion
The stock market apparently lives in a "shoot first, ask questions
later" world, since CVS seemed to fall almost at the moment that its
management updated guidance.
CVS adjusted its 2013 EPS forecast to a range of $3.90 to $3.96, from the previous $3.89 to $4.00. Eagle-eyed
readers will note the midpoint has been lowered to $3.93 from around
$3.95. Before you rush to pull the sell trigger, you should consider a
few things.
First, CVS outlined that it has had to delay share purchases this
year while it reached a settlement with the SEC over previous actions.
In other words, the ‘S’ bit in ‘EPS’ is larger than it was expected to
be at this stage in the year. Moreover, CVS outlined that the timing
issue could reduce full-year EPS by “as much as $0.04.” In other words, it could reduce earnings by more than it just lowered its mid-point by. In this sense, CVS just raised guidance.
Secondly, on the conference call, CVS argued that its key target of
retaining 60% of the customers gained following the Express
Scripts/Walgreen debacle was well on track. Management declared that it
was “very confident” that at least 60% would be retained in 2013, and
this augers well for the next few quarters.
Thirdly, all of its long-term growth prospects remain in place. The
trend towards increasing generic drug sales continues apace, even if
last year’s strong growth will make the second half’s comparables a bit
tougher for CVS. CVS and Walgreen are both key
beneficiaries of this trend, because generics tend to come with higher
margin for the retailer. However, though they slow revenue growth due to
being more cheaply priced.
Another positive trend-welcomed by cost conscious consumers is each
store's increase in private-label brands. In addition, CVS and Walgreen
are both keen to personalize offerings by using the huge amounts of data
that they both have on their customers' spending habits. In particular,
Walgreen is trying to increase retail traffic by using its balanced reward card program.
Still a good value
Analysts will spill a lot of ink debating the merits of Walgreen vs.
CVS, but frankly, both stocks look good value on a historical basis.
There is no rule of investing that says you can’t hold both. Both stocks
have seen some dramatic increases in cash flow generation as the
long-term benefits (discussed above) start to drop into the bottom line.
Readers should note that during the time period in the following
chart, Walgreen lost some of its business because of the Express Scripts
impasse.
In addition, don’t let CVS’s trailing free cash flow numbers fool
you. In its conference call, management reaffirmed guidance for $4.8
billion to $5.1 billion in free cash flow for 2013. This figure
represents around 6% of its current enterprise value, which suggests
there is plenty of room to grow its dividend.
The bottom line
In conclusion, the market has somewhat overreacted to these
results. Despite its strong rise over the last year, CVS still looks
like a good value. Long-term demographic trends favor the drugstore
industry, and there was even some noise about CVS following Walgreen’s
lead in terms of making substantive international investments. There is
plenty of upside potential in the sector, and it represents one of the
safer ways to invest in health care right now.
You rarely find stocks with double-digit growth prospects and
high free cash flow yields, but when you do, it usually makes sense to
pick some up.
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