Sticking Through Bad Times: 3 Pharmacy Stocks to Buy

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

From earnings losses to major customer disputes, pharmacies have been through a lot of turmoil. In my view, however, you should stick with them through the challenging times. With several pharmacy stocks trading at a discount to the S&P 500 despite excellent fundamentals, the potential for outperformance is very real.

Walgreen (NYSE: WAG) & CVS (NYSE: CVS) Are Both Undervalued

Walgreen may have lost the Express Scripts network, but it still has taken meaningful steps to offset the negative impact. The loss was devastating, given that the network represented more than a tenth of all prescriptions last year, but customers are starting to return. Marketing efforts, like a $25 gift card, have been convincing. The decision to acquire Alliance Boots will help the company expand its geographical footprint, and thereby better compete against more expansive rivals.

Even now, it trades attractively at a respective 14.8x and 9.7x past and forward earnings, with a forecast for 12.8% annual EPS growth over the next 5 years. This compares to corresponding figures of 16.3x and 12.2x with a 12.7% forecast for CVS. Accordingly, Walgreen is preferable against its peers strictly by these metrics. Yet analysts still rate CVS a "buy," versus a "sell" for Walgreen. 

Recent results have also been generally good. In 4Q of FY2012, Walgreen's EPS of $0.63, while down, was ahead of expectations. CVS, however, has been more consistent in beating expectations over the past 5 quarters.

However, if you are thinking about buying shares of CVS, understand that it has its own headwinds. It has been reported that the federal government is exploring whether or not the pharmacy violated Medicare rules, such as refilling prescriptions without approval. In my view, however, the risks are relatively limited in light of the company's recent $6 billion stock buyback announcement.

Rite Aid (NYSE: RAD): Today's Struggles Will Give Rise To Tomorrow's Strong Returns

If you are looking for a firm that is really in turnaround mode (even more so than Walgreen), look no further than Rite Aid. Over the twelve trailing months, it has lost $0.33 per share and is expected to lose $0.09 next quarter.

Even though analysts still rate the company closer to a "sell" than a "buy," that doesn't mean Rite Aid isn't worth your time. In my view, it is an ideal takeover target for pharmacies to gain scale. The last two quarters have been substantially better than expectations, with the company even yielding positive results in 2Q 2012 (not fiscal year)!

Strong growth in front end sales and prescription count has been reflected in adjusted EBITDA of $218.7 million for the most recent quarter. Net loss was also sequentially decreased by $53.5 million, while generic penetration has grown 4% over the same quarter last year to 80%.

The firm clearly has a credible economic moat. But it needs to badly improve its capital standing, as evidenced by the poor quick ratio of 0.5x. Investors that stick with the company as that capital standing improves from growing free cash flow stand to reap significant upside.


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