Investing in Your Corner Drug Store

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

As the health care law enters its last few stages of implementation, and with the looming “patent cliff” on the horizon for many drug companies, the state of the health care industry in America is in limbo. One area that is the most curious for many people, and many investors, is in pharmacies, and how they will respond to the growth of generic drugs on the market, as the upcoming patent cliff predicts. While this may mean a downside for drug companies and manufacturers, it liberates customers dependent on prescription drug coverage, as they can choose generic equivalents at cheaper prices. This could be a huge boon for both pharmacies, including CVS Caremark (NYSE: CVS)Walgreen (NYSE: WAG), and Rite Aid (NYSE: RAD), and investors.

Generics: Bad for drug companies, good for pharmacies

This year, generic drugs are already having an impact on the bottom lines for these three companies, as sales of generic drugs are increasing in the pharmacy stores of each retailer. For CVS Caremark, retail pharmacy volumes increased by 2% last quarter, although the last 3 months saw only a 0.1% revenue increase, and an actual drop in same-store pharmacy sales by 2.3%, though the company attributes this to an early Easter Sunday rather than a sign of long-term malaise. However, the generic dispensing rate has been steadily increasing, and that should help in terms of profiting off sales of generic drugs as they become more numerous with time.

Walgreen has continued its recent winning streak with three straight months of sales growth, posting a 4.3% monthly sales increase, and a 3.3% increase for the quarter. Generic drugs have contributed to Walgreen's boost in sales at the pharmacy counter, just like at CVS. They should keep the chain's winning streak alive into the summer.

Rite Aid, though, has been the laggard of these three, and the introduction of generics has not helped as much as it should have. Pharmacy sales have dropped 2.7%, while same store sales also dropped 1.5% year-over-year, which stands in stark contrast to the strong sales figures of their two competitors. It also hasn’t been a good quarter for Rite Aid either, with same store sales dropping 2.8% for the quarter. Generic drug introductions should help the company with its sales, but Rite Aid is showing problems beyond the advantages of the coming “patent cliff” that is helping its competition.

Increasing storefront counts point to future success

On the whole, pharmacies have been popping up in more places across the US, and into other countries for some stores. CVS Caremark announced 28 new American outlets during the last quarter, which is the result of a strong quarter that saw a 21% increase in operating profits year-over-year in the first quarter, along with a free cash flow of $1.3 billion for further expansion. Walgreen opened up 12 stores last month, bringing a net increase in storefronts to 70 year-over-year, while Rite Aid, despite posting a strong May, reported 39 fewer storefronts year-over-year. This isn’t a good sign for Rite Aid, even though gross margins for the company have improved and net income estimates are expected to be a healthy $75-$90 million for the quarter, providing further evidence that Rite Aid has some problems.

Who is good, who is bad

Walgreen is far and away the best of the three companies for investors, not only because of a great stock history, but also thanks to its strong current numbers. Last quarter, dividends paid out 27.5 cents per share, making it 322 straight quarters of payouts (that’s over 80 years!). It also can boast 37 straight years of increasing annual dividends, with this year seeing a 24% increase in the compound annual growth rate. With a P/E of 21.79, it isn’t exactly affordable, but with a 12.19% ROE and an E/P ratio of 4.58%, it's probably worth a little splurge, especially with the consistency of its dividend payouts and sales increases.

CVS Caremark is a more affordable option for those looking for a solid player in the industry with a P/E of 18.10 and a ROE of 10.65%. It’s a solid option, and it is a growing company with the strong growth in operating profits as well as solid franchise expansion. It also has a higher E/P ratio of 5.54%, giving it better yields than Walgreen. Dividend payouts though are more unpredictable though, so that is something to consider when making a stock purchase.

Rite Aid has been the weakest of the three, and it is starting to recognize and correct problems that are making it the third-place contender. On June 7, the company announced the issuance of a $500 million loan to bring down increasing interest expenses, as well as narrowing its EPS range. It beat Street estimates last quarter, so it isn’t a bad company, though with decreasing profits, storefronts, and quarterly sales, it can do a lot better. It is the most expensive stock of the three, despite a share price of around $3/share. Its P/E is the highest at 24.98, while its E/P is the lowest at 3.96%, as well as a negative ROE of -4.8%. It should improve with the new refinancing plan, but it isn’t a buy just yet.

It can be safe to say that the pharmacy business will be a strong mover in the days ahead, even if the stock market is showing signs of slowing down. If the “patent cliff” materializes in 2014, each of these three companies should be able to benefit while drug manufacturers take a bit of a hit. It is a good time to get into your corner drug store's stock. Business could be booming soon.

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John McKenna 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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