Drugstore Stocks: Walgreen and CVS Stand Above the Rest

Investopedia Advisor submits: Local mom-and-pop corner drug stores that once dotted virtually every town center are almost gone. They’ve been replaced by 24-hour mega drugstores, that double as mini supermarkets. Of course, the ambiance of the small stores and the soda counters is something I miss.

But, I can’t help but think about how convenient these newer drug stores have become. They sell everything! They have, in effect, become a staple of the North American way of life.

And with a number of the big name chains releasing their June same-store-sales numbers over the past week, it provides us with an opportune time to give the group a look.

Walgreen Co. (WAG): The chain opened 46 stores during the month of June, which will contribute to its impressive double-digit revenue growth in the coming months.

But more importantly, and perhaps more indicative of a trend, same-store-sales increased by 9% (about 1% to 2% better than Wall Street expectations) during the month of June.

That’s amazing. Think about it. Most consumer goods related companies are lucky to see low single digit growth every year. These types of numbers indicate that the company is doing a terrific job managing their inventories and purchasing its merchandise from manufacturers.

Interestingly, pharmacy sales, which constitute about 66% of total sales, were up 11.6% for the month. And total prescriptions filled were up about 6.5%. This is good because it means that the company is “stealing” away customers from the competition. It also means more store traffic, and the potential for the company to sell more higher-margin private label merchandise (such as over-the-counter medicines) in the front of the store.

In short, I think the company is well on track to earn $1.71 a share (which is the current consensus estimate) for the fiscal year ending August 2006 and $1.98 a share in fiscal 2007.

Based upon June numbers and the increase in the prescription rates, which is a really important number, I think the 2006 numbers are pretty conservative. Realistically, I think the shares are worth $53, or about 15% more then their current value.

CVS Corp. (CVS): For the month of June, comparable store sales increased a very healthy 8.4% over last year. The numbers were about 60 basis points better than Wall Street expectations. In all, it was a very good month, and a terrific sign that the third quarter is shaping up as well.

To me, CVS as compared to Walgreen, is like comparing Lowe’s (LOW) to Home Depot (HD). CVS, like Lowe’s, is actually expected to grow faster then its rival over the next year (24% earnings growth, as compared to roughly 15% for Walgreen). In addition, its adding new stores like crazy and doing everything in its power to grow its revenue line and challenge its chief competitor.

While I don’t think CVS is likely to eclipse Walgreen over the next couple of years, because of their ambitious growth plan and superior margins there appears to be room enough for two big players within the group.

What’s more, I think that if the company is able to earn $1.50 a share (for the year ending December 2006), and $1.86 a share in 2007, as is what is expected, the shares could trade north of $38 a share. This would be a roughly 22.5% improvement in the share price. Again, its ability to compete and grow in spite of the competitive environment, makes the shares, at least in my mind, a better value then Walgreen.

Rite Aid (RAD): Same-store-sales rose 3.6% in June. The numbers were buoyed by a 4.7% comp store improvement in pharmacy sales. This was slightly better then the 3.4% improvement Wall Street was looking for.

Don’t get me wrong. A single-digit comp store improvement is good. But it’s not great, and when compared to Walgreen or CVS, I simply can’t justify buying the shares. For the fiscal year ending February 2007, the company is expected to break even, while in fiscal 2008 the company is expected to earn just 6 cents a share. It’s tough to value a company with such anemic earnings.

To be clear, Rite Aid has come a long way. It’s improving its store décor. It also plans to open about 125 new stores over the next year, in order to compete with larger chains. It also is constantly looking to improve its front-end (meaning front of store) merchandise mix. But Rite Aid is having trouble keeping up with the bigger fish in the pond, both in terms of store footprint and available funds to finance new growth.

And, unless the company can show some caveat of strength either in superior front end or pharmacy sales, or a dramatic increase its gross margins which are among the lowest in the industry, I think it makes sense to sit this one out on the sidelines.

Longs Drug Stores (LDG): Longs reported roughly a 2.5% increase in comp store sales for the month of June, which is, in a word, average. It’s also a company that has about one tenth of the store base of Walgreen and CVS, and is geographically beholden to its footprint, which is primarily found in California and Hawaii.

In short, it’s a decent chain that is likely to be acquired by the larger players down the road. But when and at what price is anybodies guess. Frankly, I think there are better opportunities out there.

What about companies like Wal-Mart and Target?

There are some investors that think buying shares of companies like Wal-Mart (WMT) and Target (TGT) that sell pharmaceuticals and health related merchandise is a great play on the drug industry. I disagree.

Their margins are lower. They also have a host of other retail merchandise that often has greater seasonality, and is more dependent on fads. In short, Target and Wal-Mart are discounters, not high-end drug stores with a loyal customer base, and as such, you should not confuse them with a pure play on pharmaceutical related sales.

By Glenn Curtis, Contributor - Investopedia Advisor

Glenn Curtis started his career in the 1990s as an equity analyst for a regional firm in New Jersey. There, he covered companies in the technology, entertainment, and gaming industries. Curtis has since worked as a financial writer at a series of both web and print publications, including TheStreet.com and Registered Rep Magazine. He has held his series 6,7,24, and 63 securities licenses.

At the time of release Glenn Curtis owned no shares in any of the companies mentioned in this article.