CVS Is a Good Example of a "Sleeper Hit" Stock

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CVS Caremark is one of those stocks that appears as if everyone knows what it is and where it's going, and seems predictable enough, but ends up surprising everyone with gains out of nowhere. Akin to the stock version of a "sleeper hit" movie. The company has been around for over 30 years, but in the last year the stock somehow managed to log almost 28% growth in it's share price. It'd probably be a good idea to buy this stock and hold it. It will pay to stick around, as you will soon see.

Where did the growth come from?

In short, it came from an aging baby boomer population, some 70 million strong.  Walk into any CVS store and the first thing you'll notice is the older clientele. They need meds, and this is expected to accelerate through 2017 . CVS is primarily a drug store, wherein it derives the most of its revenue from prescription drug sales (mostly high-margin off name brands).

Perhaps more great news for the drug business is that baby boomers may not be just the largest generation (before the millennials), but also the unhealthiest. Folks born between 1946 and 1964 were more likely to suffer from high blood pressure, high cholesterol and diabetes than the previous generation. Diabetes and weight-related spending are $177 billion and $144 billion respectively, and that's just in the United States. Let those numbers sink in for a moment. I'll wait.

Battle of the pharmacy titans

Competitors Walgreen (WAG) and Rite Aid (RAD) are right behind them. I'd say either of the three are pretty good bets, due to an aging U.S. population and the health habits of baby boomers. Rite Aid and Walgreen have risen 143% and 50% respectively in stock price in the last 5 years. Not bad. Yet, what sets CVS apart is they have a much more aggressive store strategy and are better at capturing revenue.

As of now, CVS has currently 7,400 stores in North America, and there are new ones continually popping up all over. There is a difference of about 600 stores between Walgreen and CVS, which gives CVS a bit more runway for growth. CVS also has more cash, almost $1.4 billion, than either Walgreen or Rite Aid and a larger revenue and profit base, bringing in $122 billion in revenue and $3.8 billion in profit last year. Margins between Walgreen and CVS are roughly the same (3.4% and 3.1% respectively) but CVS is clearly in a better competitive position from a cash and revenue standpoint. They can leverage their cash position to build more stores, make acquisitions, and still bring in more cash every year due to their sheer revenue size.

Walgreen has more stores, 8,096 at last count, but way less revenue, and it's becoming less and less known as a "drug store" and more a convenience store. It seems as if they are competing less and less on drugs and more on convenience, like 7-11. So while their recent remodeling initiative is a nice change, it seems to take the focus away from their core product, which is, well, drugs. 

Rite Aid is the smaller competitor to both these two giants, but the same demographic and economic trends affecting its two larger competitors will benefit it too. Just on a smaller scale. According to their site, they have just over 4600 stores and a stock price (about $3 at time of writing) low enough to almost qualify it as a penny stock.  It's easy to see why their their stock has jumped so much from 5 years ago, so quickly. But I don't see them quite catching up to Walgreen or CVS anytime soon.

The future is looking even better

Meanwhile, CVS is improving and expanding its drug and health business. They're expanding their "MinuteClinic" concept, a system of retail health clinics for minor illnesses, currently responsible for $190 million of their revenue yearly, or about .01% of total ($123 billion), from 640 to 1,500 by 2017, that means revenue from this unit should also double. Compare that to competitor Walgreen's similar "Take Care" clinics  at 360, or Walmart's 130 clinics. CVS is way ahead in this space, no other major retailers come close! It looks like that will only accelerate in the coming years.

Their specialty pharmacy business, which basically means drug and drug management programs that are tailored to a customers complex, unique medical needs, are growing at a rate of 17.3% every year. It already represents a $17 billion business for CVS, so 17% growth in just one unit, is a pretty substantial increase for an already massive business.

Their retail clinic unit, specialty drug unit, combined with the the inevitable generational demographic shifts taking place and that will continue to take place up into the 2020's, means they will be well situated for continued growth.

Don't sleep on this one. Check my blog for future updates on this stock and where it may possibly be headed.

Marcus Tisdale has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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