Retail Pharmacy Stocks Continue To Rise Despite Stiff Competition

by: Glen S. Woods

CVS Caremark (NYSE:CVS) has risen 12% year-to-date, Walgreen Company (WAG) is up 25% year to date, and even the battered Rite Aid Corp. (NYSE:RAD) is up 28%. What makes these numbers so impressive is that these companies are growing despite stiff competition from large retailers such as Wal-Mart (NYSE:WMT) and Costco (NASDAQ:COST) that sell many of the same generic drugs at a much steeper discount than smaller retail pharmacies, some by as much as 447% less.

Big-box stores such as Costco Wholesale and Wal-Mart Stores have such a wide variety of departments and do not rely on its pharmacies for the bulk of its profits. Therefore, they can utilize the in-store pharmacies more as loss leaders to bring in more foot traffic, enticing buyers to shop for other goods as they wait for their prescription to be filled. Chain store pharmacies do not have that kind of luxury, as they still make the majority of their revenue and profits from prescription pharmacy sales. However, retail pharmacies nationwide still account for over 80% of the prescription filled. That is because, even though the larger retail pharmacies carry front end products, consumers still perceive pharmacies as businesses that focus primarily on pharmaceutical products, and consumers have come to expect better pharmacy-related services such automated prescription refills, more detail on drug interactions, and 24-hour pharmacies.


CVS Caremark is the largest United States drug retailer, filling an estimated 990 million prescriptions in over 7,400 retail pharmacies. For 2012 it had revenues of $123.13 billion with $63.1 billion coming from prescription drug sales. The company showed earnings of $3.88 billion, or $3.03 per share. The company plans on opening between 100 to 200 new CVS pharmacies per year. CVS also has carved a niche with its 640 MinuteClinics inside its retail pharmacies, and plans to expand to more than 1,000 in the next three years. MinuteClinics provide basic medical services to walk-in patients without the need for a prior appointment. Since its inception, MinuteClinics have seen more than 15 million patients, and could be very profitable for CVS in the future when the Affordable Care Act is fully implemented and seeing a doctor becomes more difficult due to the deluge of newly insured patients. MinuteClinics will be staffed with nurse practitioners who can diagnose, treat, and write prescriptions for common illnesses and treat minor wounds. They will also administer vaccinations and assist consumers in lifestyle changes to improve their current and future health, including screenings and monitoring for diabetes, high blood pressure, and high cholesterol. CVS is a $67.95 billion market cap company, and expects 2013 adjusted earnings to rise between $3.86 and $4.00 per share. Year-to-date the stock has risen over 14%, and closed on Wednesday, April 4th at $54.13. I look for CVS to continue to grow in 2014 and should see new highs.


After WAG's nose was bloodied by its spat with the giant mail order pharmaceutical company, Express Scripts, (NASDAQ:ESRX), WAG realized that, to be able to throw its weight around, it must expand…and expand it did. In the middle of March, Walgreen announced it agreed to a 10-year pharmaceutical contract with the wholesale pharmaceutical company, AmerisourceBergen (NYSE:ABC), dropping its previous distributor, Cardinal Health Inc. (NYSE:CAH). Walgreen will have the ability to purchase a minority position of up to 7% of AmerisourceBergen and will receive equity warrants exercisable for an additional 16% of the company. What Express Scripts showed Walgreen was that the company who has the higher number of orders has the ability to dictate price. In the agreement Walgreen will buy $28 billion annually in drugs from ABC, which will push more volume through its wholesaler's distribution network, and should bring wholesale costs down, giving Walgreen a stronger position to put pressure on suppliers. The deal gives AmerisourceBergen access to generic drugs and related pharmaceutical products through Walgreen, giving AmerisourceBergen the opportunity to grow its specialty and manufacturer services businesses, both domestically and internationally. In 2014 AmerisourceBergen will assume distribution of generic products that Walgreen has previously self-distributed.

Adding to its size, Walgreen has taken more of a global approach when it acquired 45% of the European pharmacy, Alliance Boots GmbH, for $6.7 billion, creating the world's largest drugstore and pharmacy retailers with more than 11,000 stores in 12 countries. Walgreen has the option to buy the remaining 55% stake in Alliance Boots down the line for $9.5 billion in cash and stock, though WAG would have to assume the roughly $11 billion debt of Alliance Boots.

Walgreen, a $43.76 billion market cap company, filled 785 million prescriptions totaling $42.8 billion in sales, which accounted for 63% of the company's $71.6 billion in 2012 net sales. For the fiscal second quarter that ended on February 28th, WAG reported net income of $756 million, or $0.79 per share, up from $683 million, or $0.78 per share, in the previous year's quarter. On April 4th the company announced its March sales numbers, and it continues to impress, as sales rose to $6.16 billion, an increase of 2.3% over March 2012's $6.01 billion. After announcing its March sales the stock hit a 52-week high of $48.18, but settled back to close at $46.30 per share.


Rite Aid has had its fair share of problems; it saw sales drop and debt rise. But it looks like the company has put the brakes on the downturn and has cut its debt finally below $6 billion. The company has also closed some underperforming stores, and is focusing on building up its customer base in its remaining stores. Rite Aid also has found that its Wellness + program is bringing customers back into it stores, as members of the program accounted for roughly 70% of prescriptions filled and 75% of front end sales.

RAD expects 2013 fiscal year sales could reach $25.3 billion, a drop from 2012 revenues, where the company saw growth of 3.6%. The company lowered its net loss for fiscal 2012 to $368.6 million or -$0.43 per share, compared to its fiscal 2011 where it saw a net loss of $555.4 million or -$0.64 per share. The company also upped its EBITDA for Fiscal 2013 from $950 billion to $1.025 billion, to $1.050 to $1.075 billion. RAD is much smaller than CVS or WAG; it has a market cap of $1.58 billion. In order for the company to survive it must make a niche for itself, be it in very superior customer service or in expanding its Wellness + program to attract new customers. The stock is very risky at this point, but it might have some room to rise.


There is also a niche market within the retail pharmacy business. PetMed Express, Inc. (NASDAQ:PETS) is an excellent example of such a niche market. PETS markets prescription and non-prescription pet medications and other health products for dogs and cats, direct to the consumer, and have done quite well carving out its niche serving over 6 million customers. PETS, like the big chain pharmacies, is a licensed pharmacy accredited by the National Association of Boards of Pharmacy. And though it is now facing stiff competition by both Wal-Mart and Amazon, PETS has built its business into a $267 million market cap company, with net revenue for fiscal 2012 of $231.6 million, and net income of $20.9 million, or $0.92 diluted per share. The company's quarterly dividend was increased from $0.10 per share to $0.125 per share paying approximately $10.7 million in quarterly dividends. At the same time the company bought back approximately 791,000 shares of common stock for approximately $12.2 million. PETS stock closed at $13.34 per share. It has a P/E of 16.19 that is lower than both WAG and CVS, and the company has no debt.

Another pharmacy starting to carve out a niche in the industry by specializing in the highly regulated pain medication business is Assured Pharmacy Inc. (APHY.OB). The company has risen over 22% YTD. Just as PETS, this company may have found a strong niche in the retail pharmacy market. Over 75 million Americans have debilitating chronic pain and 2/3rd of sufferers continue to experience pain for longer than 5 years. 75% of the visits to a doctor are due to pain, and sufferers shell out $30 billion per year on prescription pain medication. Most larger retail pharmacies and big box stores are reticent to carry many of the pain medications due to heavy government regulations and the concerns of theft. APHY has a fully diluted market cap of around $23 million, when taking into account the outstanding preferred shares of the company. The company generates gross revenues in excess of $16 million annually in the pain medication arena.


The big box retailers will continue to take a share of the pharmacy business, but with the coming Affordable Care Act, there will be millions of new customers for the pharmacy business to fight over. CVS and Walgreen continue to impress, and have shown both companies are willing to be aggressive in bringing in new customers, be it by expanding globally or by offering more medical based services at more locations. Though both CVS and Walgreen are near record highs, I still see plenty of room for the stocks to grow, and both would be strong long-term investments. Rite Aid is far more of a risk: its debt is still far too high for its size, unlike the specialty companies that were profiled. These specialty companies, APHY and PETS, are growing and do not carry such debt. Either might be a better buy than Rite Aid.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.