Should We Be Bullish on This Retail Pharmacy's Dividend?

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

The largest pharmacy and healthcare provider of the country, CVS Pharmacy (NYSE: CVS) has been strongly confident about the growth of the business, with the significant increase in demand of specialty drugs under Obamacare, starting in 2014. Recently, CVS has reaffirmed its FY12 guidance and also raised its quarterly dividend by around 38%, to $0.225 per share, which would be paid on February 4 next year to shareholders on record of January 24. It sounds exciting, and before taking any actions based on the bullish news, we need to look deeper into the business fundamentals and the company's outlook. 

Strong 2013 ahead…

CVS has given to shareholders a strong guidance for 2013. The pharmacy retailer estimated to deliver adjusted diluted operating EPS of $3.84 to $3.98 per share, with a growth range of 13.25% to 17.25%. It also expected to generate $6.4 billion to $6.6 billion in operating cash flow, delivering $4.8 billion to $5.1 billion in 2013. More interestingly, the company assumed that it would complete the $4 billion in share buybacks in the next year. In addition, the dividend has been increased to $0.225 per share as mentioned above, raising the annual dividend to 90 cents per share. At the current trading price of $48.50 per share, the dividend yield would be more than 1.85%.

The CEO Larry Merlo believes in the strong growth of around 10,000 baby boomers being eligible for Medicare everyday. Dave Denton, the executive VP and CFO commented:

“In late 2010, we set a dividend payout ratio target of 25% to 30% by 2015, which implied a compounded dividend growth rate of approximately 25% per year from 2010.  Today's increase allows us to meet our 25% dividend payout ratio target two years early and marks our tenth consecutive year of dividend increases. We remain committed to using our free cash flow to enhance total returns for our shareholders through a combination of high-return investments, dividend increases and value-enhancing share repurchases."

Historical impressive operating performance

In the last 5 years, CVS has delivered a quite sustainable increase in both the top and bottom lines, and especially, the consistent growth in dividends. 

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CVS Revenue TTM data by YCharts

The company’s revenue and EPS have experienced quite compatible growth, about 57.3% and 52.6%, respectively. Over the trailing twelve months, CVS recorded $2.94 earnings per share. What would impress income investors is the consistent growth in its dividends. In 2002, it paid out $0.20 in dividends per share, and it has increased to $0.50 per share in 2011. Income investors might rest assured that CVS maintained quite a conservative payout ratio, by only 19.3% in 2011.

Walgreen Might be a Better Pick?

During the last 5 years, its performance has been in between of its two competitors, including Walgreens (NYSE: WAG) and Express Scripts Holding Company (NASDAQ: ESRX).

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CVS Total Return Price data by YCharts

Express Scripts is the best performer, with a 53.2% total gain, whereas Walgreens is the worst, with 10%. CVS stands in the middle, with more than 31%. The loss of Walgreen might be due to the fact that it has lost its customers to CVS during its dispute with Express Scripts on a prescription issue. With the similar trailing twelve month net margin, Walgreen and CVS are valued similarly in the stock market: CVS of 8.1x EV/EBITDA and Walgreen of 8.28x EV/EBITDA. Even with the nice increase in the dividends, the dividend yield of Walgreen is still far higher, with 2.7%, compared to 1.85% of CVS after the dividend increase. Among the three, Express Scripts is the most expensive, with 13.5x EV multiples, but it had the lowest margin and the lowest return on capital, of only 1.4% and 4.8%, respectively. 

My Foolish Take

CVS might make a nice run in 2013. Indeed, all three stocks would perform quite well in the long run with the established market leading positions in the US healthcare market. However, fundamentally, I am more inclined to Walgreen due to its higher return on invested capital, higher dividend yield, and similar valuation. 

hoangquocanh has no positions in the stocks mentioned above. The Motley Fool owns shares of Express Scripts. Motley Fool newsletter services recommend 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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