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Brazil Makes Sense for CVS

Eric is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

CVS (NYSE: CVS) continues to grow in the United States, attracting shoppers from independent pharmacies and weaker big box chains. This pharmacy giant still risks hitting the wall in the domestic market if lucrative pharmacy expansion spots run low. Competitors Rite Aid (NYSE: RAD) and Walgreens (NYSE: WAG) face similar domestic growth constraints, and Walgreens addressed this challenge by entering the international market. Now CVS has international expansion plans of its own, but this pharmacy chain chose a cautious expansion plan that will take time to pay off.

Brazil's medicine market

CVS decided to set up shop in Brazil, which has a large market that tempts many multinationals, by purchasing the Drogaria Onofre chain. Medicine sales in Brazil have demonstrated dramatic recent growth. German pharmaceutical company Boehringer Ingelheim, which is private, explained that in 2011, total medicine sales in Brazil rose 19% to $26 billion. 

Pharmacies in Brazil can also achieve higher margins through generic medicine sales. Boehringer Ingelheim explains that 20% of the medicine sold in Brazil is generic right now. This figure shows that generic sales have room to expand even further in Brazil, so CVS can benefit from this trend in both the United States and Brazil markets. Generic sales also help Walgreens and Rite Aid as well.

Conservative strategy

CVS didn't make the largest deal it could afford here, but shareholders might question a big buy. Peter Frost, at the Chicago Tribune, reported that investors criticized Walgreens' decision to spend $6.7 billion on Alliance Boots in 2012 at its annual shareholder meeting. Although this deal mainly provided access to the British market for Walgreens, Alliance Boots does business in many parts of the world, including China, Egypt, and Saudi Arabia. Alliance Boots hasn't entered South America so far, but this British pharmacy could help Walgreens if it decided to go after the Brazilian market itself.

CVS went for a much smaller purchase in Brazil, spending less than a tenth of what Walgreens paid last year. Jessica Wohl, at Reuters, reported that analyst Ross Muken estimated that Drogaria Onofre sold for about $600 million. With $1.2 billion in the bank, CVS can afford to pay cash for Drogaria Onofre with money left over to expand the business in Brazil.

Domestic competition

CVS might also face renewed competition in the domestic market. Walgreens' trailing P/E of 18.7 and forward P/E of 11.2 on the morning of February 7, 2013 imply stronger earnings this year, which could mean regaining customers from CVS and Rite Aid. Expectations remain low for Rite Aid, even after its profitable quarter, and a forward P/E for the pharmacy doesn't appear on Yahoo! Finance. Rite Aid did report 0.3% higher same store sales for January because of the relatively severe flu season, which provided another boost for this pharmacy's turnaround campaign.

Express Scripts (NASDAQ: ESRX) carries a trailing P/E of 32.8 that surpasses the pharmacies's figures, so its forward P/E of 13 implies much stronger income growth. Express Scripts received some good news recently when Walgreens reported 6.3% higher January sales and stated that its pharmacies served more Express Scripts customers. The flu season also boosted these results, but Walgreens and Express Scripts look like they're working well together again, which could complicate CVS's customer retention efforts. CVS has a trailing P/E of 17.4 and a forward P/E of 11.7 itself, figures that cover both its retail operations and its benefit management business, and its PEG ratio of 0.99 demonstrates a reasonable price for its expected growth.

Takeaway

CVS' Brazil play won't pay off immediately, but it does demonstrate one of this pharmacy's main strengths, its management. CVS could have bought a bigger Brazilian chain to raise its earnings and sales figures, but this would have added even more debt to its balance sheet, and possibly a large amount of goodwill as well. The Fool's David O' Hara brings up the concept of a desert island stock, a company that offers steady profits but doesn't require constant attention. CVS already looked like a decent desert island stock, and now this pharmacy offers international growth potential as well.


Eric Novinson owns shares of CVS. The Motley Fool recommends Express Scripts. The Motley Fool owns shares of Express Scripts. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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