4 Critical Factors To Consider Before Buying These Pharmacy Stocks
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
If you are interested in investing in pharmacy stocks, there are several variables that I recommend you consider: (1) market share trends, (2) corporate partnerships, (3) return on invested capital, and (4) margin trends. Market share gains all too often are accompanied by margin compression, but, if they are not, it is a good indication that the company is picking up on faster growth trends. Then, any company can grow, but if it fails to create value in the process, shareholder dollars are essentially being destroyed. For these reasons, all 4 variables are important, and particularly so for pharmacies, which face strong competition and limited global presence. Below, I review 3 pharmacy stocks with these variables in mind.
A Look At Walgreen (NYSE: WAG)
Despite a challenging year, Walgreen is surprisingly near its 52-week high after rising 30% from the lows. Can we expected continued success? The firm is desperately trying to win back Express Scripts customers that were lost in the debacle earlier this year. It even formed a partnership with Alliance Boots and bought out 45% of the company for $6.7 billion to get investors focused on upside opportunities. This partnership creates what may be the first globally successful pharmacy and healthcare enterprise, but analysts have had a tepid outlook. A majority of the 20 reporting analysts rate the stock a "hold" or worse--1 advises clients to "sell".
At 10x forward earnings and a forecasted growth rate of 12.7% over the next 5 years, however, I believe the Street's outlook is a little too bearish. Return on invested capital is still healthy at 10.4% and margins are above the industry average--60 bps greater in terms of profit margins. In my view, much of the negativity comes from a short-term outlook. October front-end sales declined 2.9%, which was well below industry expectations for 1.1% growth. But with investors now focused on the short-term volatility, "buy-and-hold" investors have the opportunity to get in before growth starts to accelerate from Alliance Boots and Express Scripts momentum.
If you are looking for even greater upside, you might be tempted into buying Rite Aid (NYSE: RAD). The retailer posted its first profit in half a decade, and this was largely credited to the company's successful execution, as opposed to general industry growth. Shares essentially reversed the 38% erasure experienced from the 52-week high. Third quarter EPS of $0.07 was 9 cents ahead of expectations and will keep investors eyeing upside. Free cash flow currently stands at a strong 21.6%.
Why You Should Buy CVS (NYSE: CVS)
Despite all the big "to do" about Walgreen's recovery of the Express Scripts, CVS has been actually gaining prescription market share. In fact, CVS expects to permanently retain around 60% of the new clients that migrated away from Walgreen. At a time when margins are trending upwards from PBM and retail momentum, CVS is a much safer pick despite the recent sell off by Warren Buffett. At a respective 16.3x and 12.3x past and forward earnings, the company is trading above its historical 5-year average PE multiple of 15.3x. However, I still see the stock as a stable "winner". Here's why:
Assuming CVS meets expectations, 2016 EPS will come out to $5.66. At a multiple of 15.5x, this translates to a future stock value of $87.73. This provides for nearly 18% average annual returns when you factor in dividends. Discounting backwards by 10% yields a present value that offers a 12% margin of safety. Thus, I believe CVS counts as both a "value" and "growth" investment.
Moreover, smart money is on the company doing well. All but 1 of 21 analysts say the stock is a "buy" or better--the one dissenter says "hold". With expanding margins and improving Med-D exposure, the company is more positioned for upside than downside. It has only rise 21.5% from its 52-week low versus 30% for Walgreen despite better-than-expected retention of Express Scripts customers. I thus recommend buying shares to take advantage of a market correction.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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!