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Pharmacy Wars: Walgreens vs. CVS

Which drug store chain is the better bet for your portfolio?


Drug store chains have had a bumpy ride since 2007 — hit first by the recession and then by anemic annual sales growth, as they compete not only with each other but with grocery stores and mail-order pharmacies.

Recently, though, consolidation and cost-cutting have helped the two leading chains, CVS Caremark (CVS) and Walgreen Co. (WAG), come storming back. (The other name in the space, Rite Aid [RAD], is much smaller than its two main rivals and has struggled more, with the proliferation of low-priced generics eating its lunch.)

Plus, the market opportunity is not limited to retail drug sales; pharmacy benefit management (PBM) is big business, too. Case in point: David Bonderman’s TPG Capital announced this week plans to acquire Envision Pharmaceutical, a PBM with about $3.5 billion in annual sales.

With that in mind, which stock — WAG or CVS — is the best bet for investors? Let’s break it down:

Walgreen Co.

Walgreen Co. has nearly 8,100 retail pharmacies, making it the largest pharmacy chain by number of stores. The company’s fiscal 2012 sales totaled more than $72 billion, on par with the prior year. However, a spat between Walgreens and pharmacy benefits giant Express Scripts (ESRX) drove the company’s net earnings for the year down to a paltry $2.1 billion — 22% lower than in 2011.

Walgreens has since worked out its differences with Express Scripts, but still missed analysts’ revenue forecast for the most recent quarter. Same-store sales also inched up less than 1% during the quarter, and customer traffic was down nearly 4%.

The good news: The company has global ambitions — particularly with regard to retail pharmacy — that became apparent this time last year when it acquired a 45% stake in European pharmacy giant Alliance Boots for $6.7 billion.

Walgreens not only has the option to increase that stake in the next couple of years, but the companies together are setting their sights on the pharmacy market in China. To that end, the companies last September bought a 12% stake in Nanjing Pharmaceuticals. All told, Walgreens stake in Alliance Boots should deliver synergies of $125 million to $150 million.

For the cherry on top, WAG pays a better dividend than rival CVS, boasting a current yield of 2.9%.

CVS Caremark

CVS Caremark has 7,450 retail pharmacies — a handful fewer than its rival — but also can add nearly 650 in-store “Minute Clinics” to its résumé. As the Affordable Care Act drives millions of formerly uninsured Americans to primary care physicians instead of hospital emergency rooms over the next few years, CVS sees a significant growth opportunity in the primary care business.

The company plans to open 150 clinics this year alone, with a goal of having more than 1,500 clinics open for business by 2017. Although WAG is pursuing a similar strategy with its Take Care Health Systems subsidiary, it currently has only 370 in-store clinics open today.

Plus, CVS is a big player in the pharmacy benefit management space through its acquisition of Caremark in 2007. CVS’s total revenue hit a record $123.1 billion in fiscal 2012, while profit from the PBM business grew by more than 20% last year. CVS is also looking to grow its 26% share of the PBM market aggressively over the next couple of years.

CVS faces its shares of challenges too, though. The main one: In the wake of last year’s $116 billion Express Scripts-Medco merger, CVS faces far tougher competition in the pharmacy benefits space. Plus, ESRX is not the only competitor gearing up to take the battle for market share to CVS. Last month, Catamaran (CTRX) inked a 10-year PBM deal with insurance giant Cigna (CI) to gain substantial economies of scale.

CVS’s dividend yield comes in at 1.5%.

The Verdict

All in all, CVS wins this one despite its lagging dividend. The main reason: The company’s PBM strategy positions it to continue to reduce costs while taking advantage of the swelling rolls of insured customers.

While Walgreens’ international strategy is intriguing — as is its investment in Alliance Boots — it doesn’t strengthen the company’s competitive position in the U.S., where the pharmacy chain is experiencing lower in-store traffic. At the same time, CVS’s Minute Clinic strategy not only calls for more clinics to be opened in more stores, but also positions those clinics as a supplement — or even alternative — to primary care physicians.

Time will tell whether that paradigm works for consumers and their primary care physicians, but the proliferation of these clinics will, at the very least, drive customer traffic into the stores — and more traffic is always a good thing for retailers.

As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities. 

Article printed from InvestorPlace Media,

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