One of the Best Deals in the Market Keeps Getting Better
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Many people would probably assume that now since Walgreen (NYSE: WAG) has mended fences with Express Scripts (NASDAQ: ESRX), that the opportunity in Walgreen's competition has passed. However, just because a new agreement has been reached doesn't change the fact that for multiple months Walgreen alienated millions of consumers by not being able to accept their Express Scripts membership. I've been impressed with CVS Caremark (NYSE: CVS) before, and after their most recent earnings release the story just keeps getting better.
With net revenues increasing 16.3% and adjusted EPS up 24.62%, you can clearly see CVS is growing at a fast pace. What's interesting is, buying CVS is almost like buying Walgreen and Express Scripts at the same time. The company's Pharmacy Services segment offers the same type of benefits that Express Scripts does. CVS's Retail Pharmacy division has over 7,000 locations and is similar in many ways to Walgreen. With the consistent business provided by the pharmacy stores, and impressive growth in benefit management, investors are getting the best of both worlds.
CVS' Pharmacy Services business turned in an impressive quarter. This division grew revenue by 28.2% to over $18 billion. Not only did the network process almost 14% more pharmacy claims, but this increase was driven by new client starts and the acquisition of the Medicare prescription drug plan of Universal American. With nearly 200 million pharmacy claims processed in the last three months, and over 20 million mail in claims, this benefit manager mirrors closely the combined capabilities of the new Express Scripts. In addition, this portion of the company should continue to show significant growth as millions of baby boomers get older and require more medicines.
While the Retail Pharmacy division was not able to keep up with the growth in prescription services, the stores did turn in respectable revenue growth of almost 7%. There were several factors that positively affected the pharmacy's results, but none more than Walgreen choosing not to accept Express Scripts patients. Overall same-store sales were up 5.6%, and pharmacy same-store sales increased 7.2%. Though front-end sales are somewhat secondary at a pharmacy like CVS, these higher pharmacy sales helped the front end of the store increase same-store sales by 2.3%. In addition, the company opened 36 new stores and closed 8 during the current quarter for a net addition of 28 new locations. The additional customers that CVS picked up from the issue with Walgreen, are likely to stick around. Customers have already switched their prescriptions, and in most cases a CVS location is within similar driving distance to Walgreen.
With CVS turning in positive results in their two major divisions, the company's financials are outstanding. I don't know that investors could ask much more of CVS management than what they delivered over the last six months. The company's diluted share count decreased 5.65% on a year-over-year basis, which occurred because the company spent almost $2 billion buying back shares. In addition, the company's dividend growth is some of the best I've seen. With a 30% increase in the dividend on a year-over-year basis, you would expect the company's payout ratio to be a good bit higher. However, in the last six months, CVS generated over $3 billion in free cash flow versus just $420 million in dividend payments. With a free cash flow payout ratio of just over 13%, investors should continue to expect significant dividend increases.
Competition & Conclusion
While CVS faces significant competition in the pharmacy field such as Walgreen, they also face diversified retailers such as Target (NYSE: TGT) and Wal-Mart (NYSE: WMT). However, the company's free cash flow and dividend growth seems to be the biggest reason to favor CVS as an investment. While each of these competitors is well known for paying and increasing their dividends, only CVS shows the potential to continue large dividend increases over the next multiple years. This is really a question of long-term investing versus short-term thinking. Investors looking for current yield would probably look at Walgreen and their over 3% dividend. Though CVS' current yield is just 1.47%, if the company continues its dividend growth of the last few years, this percentage could easily double in just the next 3 to 4 years. In addition, while Walgreen, Target, and Wal-Mart are all expected to show growth between 8% and 11.5%, analysts are starting to realize that CVS will probably outgrow all three. In the last 90 days, analyst estimates have increased to match the company's guidance. The company said they expect full-year EPS of between $3.32 and $3.38, as well as full-year free cash flow of at least $4.6 billion. The fact that CVS sells for the cheapest P/E ratio of their competition, and currently supports the highest expected growth rate is an obvious reason to favor the company. Until the stock market realizes the opportunity available, investors have a short-term window to potentially capitalize on. I would suggest investors begin their homework today on this seemingly undervalued play in the pharmacy industry.
MHenage 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.If you have questions about this post or the Fool’s blog network, click here for information.