TAKING STOCK: CVS is hot

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Dear Mr. Berko:

My financial adviser has recommended that I buy 50 shares of the drugstore chain CVS as a long-term investment. Please tell me whether you also think this is a good issue to own.

CP, Vancouver, Wash.


Dear CP:

CVS (CVS-$100.17) began life in 1963 as a discount store selling health products and beauty aids. A year later, founders Ralph Hoagland and brothers Stanley and Sidney Goldstein were running 17 units, but customers had to bag their own purchases.

The first pharmacy opened in 1967, and by the end of the 1960s, Ralph (who had been a top salesman at Procter & Gamble), Stan and Sid were running 40 stores, and 23 of their Consumer Value Stores had pharmacy operations.

By the end of the 1980s, CVS had 753 locations producing $1.6 billion in revenues.

During the following 35 years, Ralph, Stan and Sid grew CVS rapidly, acquiring such names as Revco, Arbor Drugs, Eckerd and Longs.

This year, CVS will fill over a billion prescriptions, totaling $107 billion in revenues, for stuff such as Celebrex, Keflex, Zocor, Tenormin, Xanax and, my favorite of them all, Prozac and Percocet.

That’s about 340 prescriptions per store each day, or $14 million in average annual pharmacy revenues per store per year.

And including $45 billion in sundries such as candies, hair products, books, toys, school supplies, beauty products, etc., 2015 revenues will total $151 billion.

Morningstar, Credit Suisse, Argus Financial Services, Thomson Reuters, Bank of America and Merrill Lynch rate CVS as a solid “buy,” with a one-year target price of $120 to $130.

And last January, when CVS was trading in the mid-$90s, Goldman Sachs published a provocative five-page report suggesting a $114 target this year.

Now I’m told by a Goldman source that this report may be revised upward.

During the past dozen years, CVS has performed marvelously for shareholders — rising from $16 a share to over $100.

And earnings, which have improved annually from 97 cents a share in 2003 to an expected $5.15 in 2015, have been helped by a 35 percent increase in net profit margins, from 3 percent in 2003 to 4.1 percent this year.

Management has also increased dividends annually for the past dozen years, from 9 cents to $1.24, and in that same time frame, book value has zoomed from $7.25 to $36.50.

These metrics and others continue to produce excellent numbers year after year.

CVS’ impressive numbers can be blamed on its skilled management.

Management has been enormously successful with its two-pronged strategy to maximize returns from its pharmacy.

CVS has become a top-tier pharmacy benefits manager.

This service processes members’ prescription claims, making certain that the claims comply with the benefit plan’s parameters.

And the PBM is also responsible for paying the retail pharmacy on behalf of the client.

Fortunately, large PBMs such as CVS are able to negotiate attractive discounts, keep a portion of that discount as extra profit and still give the client attractive pricing.

And management has integrated these operations vertically; as an independent PBM, it processes the claims and also manages the largest retail pharmacy business in the nation.

The 1.1 billion claims processed in the past 12 months give CVS tremendous scale advantage; CVS has the lowest selling, general and administrative costs while enjoying the highest operating profits per claim.

And that translated into impressive returns on invested capital (12.5 percent) and a superb return on shareholder equity (15.1 percent) last year.

Merrill Lynch, Morningstar and others who follow CVS believe that its record growth will continue.

Wall Street believes that next year, CVS will report revenues of $162 billion, earn $5.80 a share (which is a very low 17 times future earnings), pay another record dividend of $1.40 and post a book value of $40.

This suggests that CVS has limited downside risk and that in the coming three years, CVS could trade in the $140s and pay a $1.80 dividend.

And I wouldn’t be surprised if the stock split in the next six months. That broker has given you some bosker advice.
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Please address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, FL 33775, or email him at mjberko@yahoo.com. To find out more about Malcolm Berko and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate website at www.creators.com.

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