Caremark And Walgreen - 2 Worthy Investments

Mar.18.14 | About: CVS Health (CVS)

Summary

CVS and Walgreen are leaders in pharmacy healthcare, with strong fundamentals. Their strong financial performance, competitive position and their dynamic approach makes them good long-term investments.

Comparison of financial performance and position of CVS and Walgreen compared to the industry shows their above-average performance, superior margins and better returns.

CVS and Walgreen’s business tends to be generally unaffected by the economic downturn, that allows them to produce strong cash flow and consistently increase their dividends.

CVS Caremark Corporation (NYSE:CVS) is the largest pharmacy in the US, based on total prescription revenues. With over 7,600 pharmacies and retail stores and over 800 MinuteClinic® locations, it has reach to most of the US population. With 63 million plan members, CVS has a huge customer base that allows it to produce stable cash flows.

CVS clearly dominates the pharmacy market, and its dominance can be seen in these stats. The retail pharmacy is a $200-billion market, and CVS holds a 21% share in it. The front store market is worth $15 billion, and CVS holds 9% of it. The mail pharmacy market is worth $40 billion, and CVS holds 22% of this market. Specialty pharmacy market is worth $100 billion, and CVS dominates with 21% share, and CVS's MinuteClinic® holds 2.1% of the clinic market.

Walgreen (WAG) is the next dominant player in the pharmaceutical industry, with 74 million active members. WAG has a leadership in immunization, and it has partnership with the UN. All of these initiatives help WAG to produce strong and stable cash flows. WAG's long-term strategic relationship with Alliance Boots & AmerisourceBergen is a source of strength.

Strong Cash Flows

The cash flow is the blood of any company that allows it to exist and grow. CVS and WAG are redefining healthcare services and helping this industry to innovate to offer better services for the masses. This continuous process of innovation and improved services is only possible due to the efficient running of the business that allows both companies to produce strong cash flows.

Both companies have produced huge cash flows from operations and free cash flow after capital investment in the last financial year. CVS produced an operating cash flow of $5.78 billion and a free cash flow after capital investment of around $3.8 billion in the last financial year, and WAG produced an operating cash flow of around $4.3 billion and a free cash flow after capital investment of around $3.1 billion. This huge cash flow allows these two giants to capture every growth opportunity that they come across.

The operating cash flow of CVS rose from its 2004 level of $914 million to $5,783 million in 2013 at a CAGR of 22.75%, while the operating cash flow of WAG rose from $1,653 million in 2004 to $4,301 million in 2013 at a CAGR of 11.12%. This strong growth allows both companies to consistently make necessary capital investments and also consistently increase their dividends.

Comparison of Returns

(Data source: Reuters)

Comparing the return on equity of CVS with WAG in the last twelve months (TTM) and the last five years (as given in the table above), WAG produced a higher ROE of around 14%, compared to CVS' TTM ROE of around 12% and five-year average of 10.30%.

The return on asset measures how effectively the company used its assets, and shows that WAG's management is able to produce a better return on asset in the last twelve months and in the last five years. The return on investment produced by WAG is better than CVS.

If we compare the return performance of these two industry giants with the industry average, we see that both produced above industry-average ROEs. Return on asset is also superior for both of these companies than the industry average. CVS fell short on return on investment in the last twelve months compared to the industry.

This above-average return performance indicates that both companies are run efficiently by their respective managements. Returns are good considering the nature of the business being consumer-defensive.

Comparison of Margins

(Data source: Reuters)

If we compare the margins of both companies and the industry average, we see that the margins of CVS and WAG are not volatile, while the industry average margins have varied over the past five years, as shown in the table above. This allows us to see that both companies have consistently performed well over time. The industry's margins have improved in the last five years compared to the five-year average, showing relatively less consistency in its performance.

Now we will compare the margins of CVS with WAG and the industry average over the last twelve months and over a five-year period. WAG has much higher gross margins of around 28% compared to CVS' GP margins of around 19%. But as we move down the income statement, we see that CVS does better to control its expenses than WAG, and that allows CVS to have higher operating margins of over 6%, compared to WAG's operating margins of over 5%. As we move to the bottom line of the income statement of both companies, we find that both companies have almost the same level of net profit margins. That makes us conclude that on the whole, both companies performed equally well, with operating and net margins well above the industry average.

Comparing Dividends

(Data source: Reuters)

WAG is producing a better dividend yield at 1.88%, compared to CVS' dividend yield of 1.88%. The five-year dividend yield was also higher for WAG at 2.17%, compared to the much lower yield of CVS at 1.19%.

WAG increased its dividend from $0.18 in 2004 to $1.18 in 2013, at a CAGR of 23.24%. On the other hand, CVS increased its dividend from $0.13 to $0.9, at a CAGR of 25.24%. On an absolute basis, WAG has paid out better dividend as compared to CVS.

Both companies shared their success with their shareholders, but WAG has a higher dividend payout compared to WAG and the industry. CVS consistently paid dividends in 69 straight quarters, and it increased its dividends consistently in the last eleven years. On the other hand, WAG has consecutively increased its dividends in the last 38 years.

Conclusion

With the dominating positions of CVS and WAG in the pharmaceutical industry, both companies are well-positioned to exploit future opportunities. With a huge presence in the US market, strong brands, and infrastructure, both company produce strong cash flows that pay out decent dividends. The financial strength of both of these consumer defensive companies makes them good long-term investments.

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.