CVS, Walgreen's Fending off Wal-Mart Challenge

Moody’s expects drug store companies CVS Caremark (NYSE: CVS) and Walgreen (NYSE: WAG) to maintain their dominant position over Wal-Mart (NYSE: WMT), due to the convenience factor.

“Surprisingly, the drug store sector is one where the top players have a competitive advantage over Wal-Mart,” Moody’s says in a new report on the Drug Store Industry.

On the surface, one would expect that Wal-Mart would have impacted the drug store industry as dramatically as it has impacted the supermarket industry. However, this has not been the case. The drug store industry is one of the few retail sectors in which Wal-Mart is not the number one player in terms of revenue. We estimate that Wal-Mart’s retail pharmacy revenue is about $28 billion, placing it third behind Walgreen (at about $61 billion) and the retail pharmacy division of CVS (at about $49 billion).

We believe that the standalone retail drug stores have been able to maintain dominance in their sector over Wal-Mart by their ability to be price competitive. This eliminates Wal-Mart’s ability to differentiate on price, allowing consumers to shop for their prescriptions by what they feel is most important — convenience.

We believe that CVS and Walgreen will be able to maintain their dominant position over Wal-Mart as we expect them to remain price competitive and we don’t expect any fundamental change in consumers’ preference for convenience.

This is also one of the drivers behind why we believe that the drugstore chains are less vulnerable to the current economic environment than the discounters and the supermarkets. In addition, our opinion that CVS and Walgreen will be able to maintain their dominant position over Wal-Mart going forward is a key driver of both companies’ ratings.

CVS beat expectations for its latest quarterly earnings, while Walgreen’s fell slightly short short.

“While our business in a sense is not entirely recession proof, it’s pretty defensive, and we continue to gain share,” CVS Chief Executive Tom Ryan said on a recent conference call.

Thomas Weisel Partners LLC analyst Steven Halper noted the negative effect of Walgreen’s restructuring efforts on profit margins, but said the company reduced inventories substantially and generated “impressive” operating and free cash flow.

Standard & Poor’s issued a stable outlook for CVS on June 29, assuming “the acquired Longs stores will be integrated successfully and that a portion of free cash flow will be used to reduce debt leverage toward the mid-2.0x area in the intermediate term.”

(Disclosure: long CVS.)

Comments

[Ted Hurlbut:]

I think CVS is well positioned to hold it's own with Walmart. I'm not so sure about Walgreens. Both have convenience on their side, but I think CVS' store are better conceived and executed than Walgreen, and that Walmart's execution leaves Walgreens vulnerable.

Ted Hurlbut
www.hurlbutassociates.com

Jul 01 09:47 AM

[User 449234:]

Ted -

I think you underestimate Walgreens. From a retail execution (inventory mgmnt, real estate/location selection, etc.) standpoint, they are well above the average retailer. When looking at the difference between stores, you must consider demographic differences. CVS tends to appeal more to women and younger consumers, Walgreens does better with senior citizens (who also, consequently, love their prescription medication and value knowing their pharmacist). I fall into the former camp and can't conceive as to why anyone would prefer a WAG store over CVS, but research i have done in the space indicates otherwise. If anything, I think CVS' biggest advantage over WAG is the scale and integration of their PBM business....


On Jul 01 09:47 AM Ted Hurlbut wrote:

> I think CVS is well positioned to hold it's own with Walmart. I'm
> not so sure about Walgreens. Both have convenience on their side,
> but I think CVS' store are better conceived and executed than Walgreen,
> and that Walmart's execution leaves Walgreens vulnerable.
>
> Ted Hurlbut
> www.hurlbutassociates.com

Jul 16 04:29 PM