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Walgreen (NYSE:WAG) and Safeway (NYSE:SWY) are trading at attractive valuations relative to other stores offering pharmacy services. These companies stand to benefit from demographic trends that will lift pharmacy revenue. Among stores with pharmacies, they are two of the best stocks to buy now since investors are paid dividends to wait for price appreciation from demographic forces and from the expansion of low valuation multiples to the average of their peers.

American Demographics: The Case for Pharmacy

Older and fatter Americans are becoming increasingly medicated. The U.S. population is aging, and as people get older they buy more medication. This is very bullish for pharmacy companies. The increasing incidence of American obesity is also a boon for pharmacies because overweight Americans have more health problems, which require them to consume more prescription medications. Another trend in American society is the increasing use of medications in general. More and more ailments and disorders that were considered part of the human condition are now being medicated. Though it is not politically correct to notice that more people are on beta blockers, energy supplements, and ADHD medication, it can't be ignored as a revenue stream. This trend is good news for the top line of pharmacy stores like Walgreen.

Safeway will not see as large an increase in sales from this healthcare trend since it offers a greater proportion of non-healthcare products in its stores. However, it will see some increased foot traffic from pharmacy visits. Moreover, as we will see below, its valuations are very compelling, both on an absolute basis and also relative to other grocery stocks. Furthermore, investors who buy shares of Safeway also stand to benefit from the spin-off of Safeway's gift card business. Spin-offs generally benefit investors as the parts of the original firm are usually valued more than the whole. Safeway announced that its gift card business, Blackhawk Network Holdings, is planned to IPO in the first half of 2013.

Today's Walgreen Problems

Walgreen, the largest U.S. pharmacy retail chain, is going through a rough spot caused by ex-counterparties opting to take their business elsewhere. Walgreen reported that sales for the quarter ending in August were down 4.9%. Lower sales compared with its competitor Wal-Mart (NYSE:WMT) and CVS Caremark (NYSE:CVS) are attributed to the delay in renewal of the service agreement with Express Scripts customers, which caused comparable store prescription sales to drop by 11 percent while monthly sales for August declined by almost 8 percent. Expiration of the Tricare contract added fuel to the fire as the military personnel and military dependents health plan manager refused Walgreen an extension in December 2012.

Checking for Value

Analysts can ask when a Walgreen turnaround may happen while investors can ask a much simpler question: how much of a discount am I getting for current problems at the company?

When compared with other retail stores with pharmacies, Walgreen trades at an attractive valuation and could be a good pick for value investors:

Ticker

Company

Industry

P/E

P/S

P/B

SWY

Safeway

Grocery Stores

8.74

0.09

1.5

WAG

Walgreen

Drug Stores

14.93

0.43

1.7

WMT

Wal-Mart Stores

Discount/Variety Stores

15.82

0.55

3.61

CVS

CVS Caremark

Drug Stores

17.27

0.53

1.64

KR

The Kroger

Grocery Stores

22.01

0.14

3.3

RAD

Rite Aid

Drug Stores

NA

0.04

NA

Rite Aid may trade at a lower price-to-sales ratio, but it is currently unprofitable and it has negative equity on its books. In the long term the returns to negative equity have dramatically underperformed shares with positive net assets on their books. Safeway and Kroger offer attractive price-to-sales ratios as well, and Safeway also offers an attractive price-to-earnings ratio.

Once dividend yield and long-term growth are taken into consideration, Walgreen and Safeway look even more attractive:

Company

Dividend Yield

Payout Ratio

EPS Growth Next 5 Years

Safeway

4.33%

31.30%

9.41%

Walgreen

3.04%

38.55%

12.77%

Wal-Mart Stores

2.12%

31.86%

8.79%

CVS Caremark

1.33%

19.99%

12.69%

The Kroger

2.52%

42.10%

9.28%

Rite Aid

NA

NA

8.00%

Based on analyst estimates for the next 5 years of earnings, there is no growth penalty for buying the two cheapest stocks on this list.

Dividends further support buying Walgreen and Safeway shares. Walgreen pays an attractive 3.0% dividend with a sustainable 0.39 payout ratio while Safeway provides 4.3% dividend income with a 0.31 payout ratio. Both of these dividend yields are sustainable at these payout ratios. These dividend payments should attract investors because they show that the firm's management is willing to return capital to its owners.

Conclusion

At low valuations and with excellent long-term growth prospects, Walgreen is currently a great way to gain exposure the demographic trends driving healthcare in the United States. Safeway will also benefit, and currently trades at lower valuations than Walgreen. Both are attractive buy candidates.

Disclaimer: This article was written to provide investor information and education, and should not be construed as a guarantee or investment advice. I have no idea what your individual risk, time-horizon, and tax circumstances are: please seek the personal advice of a financial planner. This article uses third-party data and may contain approximations and errors. Please check estimates and data for yourself before investing.

Source: Tyrannosaurus Rx: 2 Dividend Stocks For Increased Pharmacy Sales