There was a time when investing in drugstores was a good idea. They sold drugs. Everyone needed drugs, and you really couldn’t get drugs anywhere else.
Times have changed.
For starters, you can now get drugs anywhere. You can get them at Costco (NASDAQ:COST), you can get them at Target (NYSE:TGT), you can get them at Wal-Mart (NYSE:WMT), you can get them online — you can even get them through Amazon (NASDAQ:AMZN).
Generic drug makers make drugs cheap, and that has pressured drugstore margins. There has been consolidation in the pharmacy management sector, so any given drugstore might find that its big contract could vanish at any time. Many insurance plans have moved to mail-in prescription plans, so drugstores can kiss that foot traffic goodbye.
So, the drugstores started to diversify into selling other products, which was a good idea. Unfortunately, everybody else started offering other products, too. Target sells everything. Wal-Mart has for a long time. Grocery stores have kept adding things. The dollar stores, like Dollar Tree (NASDAQ:DLTR), keep adding items, and most recently have added food, pressuring the grocery chains. Drugstores apparently didn’t get the memo that food sales aren’t easy to get into and stay competitive.
All this could not come at a worse time. Drug chains had just gone through a huge period of consolidation, adding tons of debt to their respective balance sheets. It has been the perfect storm for drugstores, and dry land is nowhere in sight.
What to do about drugstore stocks? Well, I can’t say Walgreen (NYSE:WAG) is in all that sorry a shape. Walgreen has half as much cash as debt, and that debt isn’t overwhelming. WAG is projected to grow at 9% annually, but why pay 13 times estimated earnings for that growth? Even the 2.6% dividend isn’t that attractive. And like I said, I see more storm clouds than blue skies for the sector. Sell.
CVS Caremark (NYSE:CVS): $9.2 billion in debt against $1.4 billion in cash. $4 billion in annual free cash flow, so at least that tells me CVS won’t go under — which is hardly reason for a ringing endorsement. And CVS is projected to see 11.3% annualized growth; again, however, it’s trading at 14 times estimates. I’ll pass.
Rite Aid (NYSE:RAD): You’re too late to the party to short it. It’s got flat to negative free cash flow, $547 million in annual debt service on $6.2 billion in debt and massive multi-year losses. Is this where the others are headed? Maybe not now, but they had better keep an eye out.
Simply put: Forget the drugstores. They’re dead investments. If you really want to invest in stores, hit up all the ones I mentioned above. They have much better prospects and far better financials.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Capital, Inc., which brokers secure high-yield investments to the general public and private equity. You can read his stock market commentary at SeekingAlpha.com. He also has written two books and blogs about public policy, journalistic integrity, popular culture and world affairs.