CVS (CVS) delivered a prescription for growth Tuesday, reporting fourth-quarter results that beat analyst expectations.
The nation’s second-largest drug store chain made news recently because of its decision to stop selling tobacco products at its 7,600 stores. Given that news and the solid earnings for CVS stock, CVS has thrown down the gauntlet and forced Walgreen (WAG) into a corner. Walgreen’s reaction should tell investors exactly how it views its competition with CVS.
The road ahead looks to be an interesting one.
CVS seems ready to chart a course less reliant on some of the traditional consumer staples like cigarettes, etc. Will CVS stock miss the $2 billion in annual revenue or 10 cents in earnings? I doubt it. As for whether its decision makes it a better or worse long-term play … well, that’s still to be determined.
Despite there being many unanswered questions, I still see CVS stock as a better investment than WAG stock. Here’s why.
Things to Like About CVS Stock
The bigger picture: CVS CEO Larry Merlo knows that healthcare is his company’s future. Selling cigarettes simply doesn’t jibe with its existing business model, which was first set in course back in 2000 when it opened MinuteClinic, a walk-in clinic staffed by nurse practitioners. Nobody, including smokers, will miss cigarette sales in its stores. It’s a bold step, but if CVS wants to be taken seriously as a “quasi” vertically integrated healthcare provider, the butts had to go … even if that means a near-term hit on CVS stock earnings.
Free cash flow: When I last discussed CVS stock, I mentioned free cash flow as one of the pros for owning it. At the time, the company suggested 2013 free cash flow could be as high as $5.1 billion, although it actually came in around $4.4 billion. However, if you add back taxes and proceeds from sale-leaseback and property disposition transactions, its adjusted free cash flow for 2013 was $7.7 billion — $200 million higher than in 2014. The cause: Its operating cash flow was a billion dollars lighter in 2013 due to higher taxes paid. That’s nothing more than a timing issue. On an adjusted basis, its free cash flow is 6% of revenue, approximately 180 basis points higher than Walgreen’s.
Share repurchases: CVS has been on a buying binge the last few years. In 2013 the company repurchased 66 million shares of CVS stock at an average cost of $60.24 per share. In the last five years it has reduced its share count by 17% to 1.23 billion. If you owned 1% of the shares at the end of 2008, you now own 1.2% of CVS stock without spending a nickel. That might not seem like a lot, but it would have increased your investment at the time by $78 million or 20% more for an additional two basis points. In that respect, shareholders have definitely won.
As for the competition…