A Strategic Look at this Pharmacy Retailer

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

CVS (NYSE: CVS) possesses many strategic qualities that should appeal to long term investors. Looking at CVS from the perspective of strengths, weaknesses, opportunities and threats will help you to determine its long term investment merits.

Strengths

Brand equity – Walgreen’s (NYSE: WAG) loss is CVS’s gain. When Walgreen’s negotiations with Express Scripts (NASDAQ: ESRX) failed on June 21, 2011; CVS benefited from the fallout. CVS’s revenue gained 13% in its most recent quarter whereas Walgreen’s revenue declined 5%.

Walgreen renewed its relationship with Express Scripts; however, according to CVS’s presentation to analysts on Dec. 13, CVS expects to retain 60% of scripts gained as a result of the Walgreen/Express Scripts impasse. Interestingly, Walgreen executives hinted at exaggerated estimates of retention rates by competitors in its last earnings conference call. However, customers value stability so the tarnished Walgreen/Express Scripts relationship bodes well for CVS’s market position.

Purchasing power – CVS commands a great deal of purchasing power allowing it to lower costs per unit of product. According to the Dec. 13 presentation to analysts, it fills an estimated 990 million prescriptions annually giving CVS the No. 1 spot in that category. Walgreen holds the No. 2 spot with 785 million prescriptions.

Furthermore, according to the presentation, CVS estimates it will command a No. 2 spot in the pharmacy benefits industry second only by Express Scripts, giving Express Scripts the interesting position of partner and competitor.

Moreover, CVS commands a respectable share of the Medicare and Medicaid Pharmacy Benefit Management markets. CVS serves 6.1 million Medicare members giving the company a No. 3 spot in that segment. CVS commands 31% of the Medicaid PBM market.

Fundamentals – In addition to CVS’s top line growth mentioned above, it possesses less total debt on its balance sheet. Its total debt to equity ratio of 76% lies below my personal threshold of 85%. In contrast, Walgreen’s total debt to equity ratio stands at 123%. Meanwhile, CVS is currently refinancing some of its debt at a lower interest rate.

Weaknesses

Domestic only – Nearly all of CVS’s revenue comes from domestic sources. Walgreen, on the other hand, announced the purchase of a stake in Alliance Boots in June 2012, an international health and beauty company with a presence in Europe and Russia.

Moreover, Walgreen’s establishment of an international presence can mean trouble if CVS decides to pursue market expansion beyond the United States. Walgreen can leverage its relationships to provide a nice stumbling block for CVS.

Opportunities

Building customer loyalty – The Walgreen/Express Scripts impasse translates into a chance for CVS to build and maintain a constructive relationship with former Walgreen customers. In other words, customers may see benefits of shopping at CVS even if their insurance carrier compels them to go back to Walgreen.

Purchasing leverage – The aforementioned purchasing power should allow CVS the ability to maintain or expand margins while passing the savings on to the consumer thus cementing retention over the long term.

Obamacare – With Obamacare a reality, CVS believes there will be a decrease of 36% in uninsured individuals over the next three years expanding its market potential.

Threats

Customer exodus – CVS faces an exodus of customers back to Walgreen due to Walgreen’s renewed relationship with Express Scripts. As noted above, CVS estimates that it will keep 60% of the customers gained. Still, the estimate may exaggerate what will actually happen resulting in a much lower retention rate than anticipated. If this happens, CVS’s fundamentals and stock price could suffer.

Regulations – Increased government regulations could result in unfavorable impacts for CVS in the form of price and supply restrictions.

Conclusion

To sum it up, CVS’s positive brand identity and purchasing power give this pharmacy retailer a decided advantage over its competitors. Its superior leverage position allows for better opportunity for financing. While CVS loses out by not expanding overseas it can capitalize from building relationships with Walgreen’s old customers. Obamacare could serve in the expansion of its markets. As has been noted, more customers than anticipated could go back to Walgreen and Obamacare could backfire on the health care industry. On the whole, CVS’s strengths and opportunities outweigh the weaknesses and threats. I’ll be giving CVS a thumbs up on the Motley Fool Caps game.


stockdissector 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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