CVS Shows Its Resilience In Any Economy

By Sham Gad | November 04, 2011 AAA

Drugstore operator CVS Caremark (NYSE:CVS) announced third quarter earnings growth of 7% over the 2010 quarter. In addition, the company forecasted a more favorable 2011 driven by growth in the number of pharmacy claims the company processed. A solid quarter and a forecast for an even better year, should be the beginning of a quality growth cycle for CVS.

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Future Growth Ahead
CVS reported a net income of $868 million, or 65 cents a share, compared with a net income of $809 million, or 59 cents a share, in the year ago 2010 period. Analysts were expecting earnings of 67 cents, not accounting for expenses related to acquisitions. Absent those expenses, CVS could be earning 70 cents per share. Profit growth was accompanied by a healthy 12% increase in sales quarter over quarter. CVS benefited from strong growth in its pharmacy benefits business, fueled by the acquisitions of Caremark and the Medicare business from Universal American. Those acquisitions have enabled CVS to directly negotiate lower prescription prices with drug manufacturers. Caremark is expected to add over $8 billion in top line growth in 2011, while the Universal American deal will add over $5 billion in sales in 2012. The company's retail drugstores grew sales by 4% quarter over quarter, while same-store sales, the true measure of retailing health, grew 2.3%, respectively. As the pharmacy business fuels prescription growth, increased store traffic should fuel drugstore growth. (For related reading, see Consumer Spending As A Market Indicator.)

Recession Proof Business
CVS is the second largest drugstore chain operator in the U.S. The largest is rival Walgreen (NYSE:WAG). Together, CVS and WAG operate in a near duopolistic industry. Much smaller rival, Rite-Aid (NYSE:RAD) has been struggling under a pile of debt. CVS currently has over 7,300 locations, while Walgreen's operates over 8,200 locations. Rite-Aid's 4,700 stores would make a decent acquisition, except for the fact that company sits on over $6 billion in debt. Moreover, CVS has been building new locations and taking advantage of cheaper building and construction costs.

With the U.S. population aging, prescription drug demand is expected to grow for years. As CVS continues to benefit from the growth, in its pharmacy benefits business, the company's top and bottom line will likely continue to grow. For 2012, the analysts expect earnings per share of $3.18, but could very likely exceed that guidance. Low prices from Wal-Mart (NYSE:WMT) is not a threat, since CVS can sell generics at the same price. The edge that CVS and Walgreen's have over Wal-Mart is that they have smaller stores, which are often a shorter driving distance than the nearest Wal-Mart. The convenience factor is a valuable one.

The Bottom Line
Trading at about 15 times trailing earnings, CVS has a very reasonable valuation for such a solid business. Prescription drug demand is growing due to a growing aging population. Healthcare is not an economically sensitive product, and will not be drastically affected by any economic setbacks. That gives the company resilience in an uncertain economy. (For related reading, see How To Do Qualitative Analysis On Biotech Companies.)

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At the time of writing, Sham Gad did not own shares in any of the companies mentioned in this article.

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