CVS Earns 'Strong Buy,' Should Outperform Walgreen

| About: CVS Health (CVS)

My CVS Caremark (NYSE:CVS) pick continues to gain since I first presented my bullish outlook on the firm. It has risen 3% within a little more than a month since I last reiterated buying the stock. The firm continues to be rated near a "strong buy" on the Street versus a "hold" for Walgreen (WAG). Based on my multiples analysis and DCF model, I continue to find that CVS will outperform its competitor.

From a multiples perspective, Walgreen is the cheaper of the two. It trades at a respective 11.7x and 11.5x past and forward earnings with a dividend yield of 2.6%. CVS may trade at 17.2x and 13.3x past and forward earnings, but it has a free cash flow yield that is 370 basis points higher than that of its competitor at 7.8%.

At the fourth quarter earnings call, CVS' CEO, Larry Merlo, noted strong performance:

We're obviously very pleased with the strong financial results we posted, along with the great progress we made across the enterprise last year.

Our accomplishments in 2011 set a solid foundation for future growth, and… we look forward to an even better year in 2012.

We reported adjusted earnings per share from continuing operations of $0.89 for the fourth quarter, $2.80 for the full year, with Retail results in line with our guidance and PBM results exceeding our guidance.

Overall, we generated about $700 million in free cash flow in the quarter, bringing the 2011 total to $4.6 billion, which beats our goal.

Fourth quarter results were largely in line with expectations. Retail pharmacy notably gained share while reimbursement pressures limited margins. PBM results were also strong due to control over the cost base. Comps for prescription sales grew 3.6%, but comps for front-end sales were weak due to poor Christmas returns. The benefit from the Walgreen-Express Scripts (NASDAQ:ESRX) dispute is estimated to be 3 cents beneficial to first quarter results.

Consensus estimates for CVS' EPS forecast that it will grow by 2.5% to $3.26 in 2012 and then by 13.2% and 13.6% in the following two years. Modeling a CAGR of 9.6% for EPS over the next three years and then discounting backwards by a WACC of 9% yields a fair value figure of $53.44, implying 23.8% upside.

Walgreen recently announced a $225M takeover of the mail service and community specialty pharmacy businesses of BioScrip. The acquisition is beneficial mostly in the sense that it diversifies Walgreen's business and helps shift attention away from the lost network with Express Scripts. The negative impact on prescriptions from losing the network drove a 1,060 basis points loss in January sales.

Consensus estimates for Walgreen's EPS forecast that it will grow by 0.4% to $2.65 in 2012 and then by 10.9% and 7.5% in the following two years. Assuming a multiple of 13x and a conservative 2013 EPS of $2.91, the rough intrinsic value of the stock is $37.83, implying 9.5% upside.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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