Which Pharmacy Giant Is Right For You?

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

When you think of pharmacies and drug stores in the United States, the two names that always come to mind are CVS Caremark (NYSE: CVS) and Walgreen (NYSE: WAG).  While both of these companies have delivered excellent revenue growth and good stock performance, which is the best choice for long-term investors? 

 

About the Companies

Walgreen is the largest drug store chain by number of stores in the US with 8,400 locations in all 50 states.  Walgreen has been very innovative in its business over the years, pioneering computerized pharmacies in 1981, and introducing the concept of drive-thru pharmacies in 1992. (Yes, Walgreen did this first!)

Walgreen filled about 784 million prescriptions last year, which translates to a 19% share of the entire U.S. prescription drug market.  A major part of the company’s growth strategy has been its active acquisitions and partnership deals.  Most significant is probably the acquisition of Duane Reade in 2012, which gave Walgreen the leading market share in New York City. 

Recently, Walgreen acquired a 45% interest in Alliance Boots, which is a leading international pharmacy store operator and wholesale drug distributor.  Alliance Boots supplies drugs to approximately 170,000 pharmacies in 21 countries, and Walgreen expects this deal to produce large savings, especially through prescription drug cost savings.  As part of the deal, Walgreen has the option to purchase the remaining 55% of the company in 2015 if it so chooses.

CVS Caremark operates just over 7,500 stores in 41 states, and actually filled slightly more prescriptions than Walgreen last year with 20% of the U.S. retail market.   The company also operates the largest chain of retail health clinics under their Minute Clinic brand name.  This is projected to be one of the big drivers of growth going forward, with 100 new clinics planned annually over the next five years.

CVS has also been very active in acquisitions, most notably Caremark Rx, which combined the two largest pharmacy benefit managers in the U.S.  Also very significant was the 2008 acquisition of Longs Drug Stores, which made CVS the largest drug store chain in California and Hawaii. 

Express Scripts

On January 1, 2012, Walgreen decided to let its relationship with Express Scripts (NASDAQ: ESRX) expire over a disagreement about payment rates.  This decision tremendously hurt Walgreen’s prescription revenue, and approximately $5.3 billion in Walgreen’s annual revenue is a direct result of their relationship with Express Scripts.  This loss was clearly felt, and 2012 was the first year in 37 years when Walgreen failed to top its sales numbers from the year before.

This move is worth mentioning for the purposes of this comparison because CVS ran advertisements specifically trying to attract former Walgreen customers, a move which appears to have succeeded.  Note from the chart at the beginning of this article how much CVS’s revenues increased from 2011 to 2012 when Walgreen’s decreased.

The two companies came to an agreement and as of last September, Walgreen is again part of the Express Scripts network.  This also speaks volumes about Express Scripts’ viability as an investment, as they seem to have the upper hand now when dealing with any of the large pharmacy chains.  With a forward growth rate of 23% projected, Express Scripts is worth a look for any portfolio, and will be the topic of a near-future article of its own.

Valuation

Back to the two companies being compared here, let’s take a quick look at their valuation and growth potential over the next few years.  Walgreen trades for 18.5 times TTM earnings; however this is somewhat deceptive due to their temporarily lower earnings due to the Express Scripts saga.  A better measure would be the consensus earnings of $3.26 for 2013.  So, at 12.7 times forward earnings, Walgreen is projected to experience earnings growth of 10.6% annually over the next few years, making it look pretty cheap.

Using the same type of comparison, CVS trades for a similar valuation of 12.9 times forward estimated earnings of $3.97 per share, which is projected to increase by 11.1% and 11.6% in 2014 and 2015, respectively, just ahead of Walgreen. 

Conclusion

Since these companies are so similarly valued, it is hard to call one cheaper than the other.  However, in my opinion, CVS has been a slightly more shareholder-friendly company in terms of share buybacks and dividend increases, both of which are tremendously important for long-term investors.  Walgreen does indeed pay a slightly higher dividend, and both companies have increased their payout amount every year over the past decade. 

What CVS lacks in dividend yield, it more than makes up for in terms of share buybacks.  In just the past four years alone, CVS has decreased the number of outstanding shares by over 15%, compared to just 4.7% for Walgreens. 

To sum it up, either of these would be an excellent addition to a long term portfolio.  Based on the buyback history and slightly higher growth rate, not to mention the fact that it has had less drama with prescription networks, I have to give the slight edge to CVS in this comparison.


KWMatt82 has no position in any stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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