Hello StockCentral. Thank you in advance for reviewing my next stock study. In these difficult investing times, I am grateful for all the insightful feed back I get from these on line studies. For this study, rather than looking at 1 company, I chose to review 2 similar companies and compare their potential for long term growth. I have chosen WAG and CVS-2 well known companies in the retail pharmacy business that also operate stores that sell consumer staples. Many feel that these companies are “Recession Resistant” because people will continue to take their medications and continue to wash and shave in a recession. In addition, because of the aging baby boomers, prescriptions filled each year will continue to trend upward.

Note: Pat refers to "slides" in the commentary.  These are included in a PDF file that is attached to this message.  Please download that file to follow the discussion.

As in the last study, I will be using the Stock Analyst (SA) program with BI S&P data. This data may differ from that provided to Investors Toolkit (ITK) by Morningstar, but hopefully the trends and judgments will be similar. I will also be attaching a Power Point set of slides to refer to. I will not go into the detail I did with FDS. Please refer to that study if you have a question concerning judgment or can’t tell where my numbers are coming from.

For the sake of full disclosure, I personally own shares of WAG. I had owned shares of Caremark, but sold them after the merger of CVS with Caremark and bought shares of WAG. (It has been somewhat painful.) Also, I am an independent investor with no formal training in finances. My goal is to go through an SSG of these companies using tools available at Better Investing and StockCentral to compare these Co.s Obviously I am not making any recommendation and would like feedback on the studies.

I will start with WAG. WAG operates about 6,200 retail stores, with a long term goal of operating 13,000 stores. In addition to the Pharmacy sales and Front End sales (non prescription medications, health and beauty, food, film processing etc), WAG has a Health and Wellness division that includes:

370 Centers in Corporate offices providing Primary Care

170 clinics in current WAG retail stores also providing Primary Care

12 Specialty Pharmacy Centers

90 Home Care/Infusion Centers

Management is acquiring and incorporating more Primary Care facilities, and    

placing more Centers in their current Pharmacies with the intent of selling more medications. Management is also investing in Specialty Pharmacy, which is the fastest growing class of new medications. (80% of all new medications are Specialty Pharmacy) These medicines are infused or injected and are not given orally. They have smaller margins but generate more sales per Rx than retail pharmacy prescriptions.

CVS is a very similar business with retail Pharmacy sales as well as Front End non prescriptions, health and beauty, photo finishing and food. In addition, CVS has a large Pharmacy Benefit Management business that accounts for nearly 50% of sales. CVS has Specialty Pharmacy and Primary Care centers. CVS therefore has 2 business divisions:

Retail Sales

Retail Prescriptions-68% of retail sales. 96% covered by insurers

Mail Order Pharmacy

Front End sales-Non prescriptions, health and beauty, etc.

Minute Clinics-500 currently

a) This division plans, designs and administers pharmacy benefits for corporations or employee groups. It is also involved in formulary management and claim processing.

Like WAG, demand for Rx is being driven by an aging population, increased incidence of chronic illnesses and increased utilization of the Medicare drug benefit. Also like WAG, sales from prescriptions has shifted to generic medicines which has lowered the sales growth but has increased the Margins the Co.s produce.

SALES GROWTH

Future sales growth is the first judgment that needs to be made. Looking at the front of the SSG for WAG, a steady and strong sales growth line is noted. However, there has been a gradual decrease in sales for the last 10 years. This is evident looking at the Balance Sheet report from SA.   It shows steady but declining growth with an R^2=100.

The obvious question is will this decreasing trend continue, and if so, how low will it go?

During the last recession of 2001, sales growth increased 16%, which is close to the sales in the year before and after the recession. It is likely that the sales growth trend has decreased due to the size and maturity of the Co. and may be permanent.

Looking at Online Take Stock (available at StockCentral) the growth screen shows the predictability of Sales and Earnings has been rated at 10 in the recent past with historic sales growth of 12.7% and historic earnings growth of 15.2%. However, because recent growth has been quite a bit lower, the overall Quality Index for WAG has dropped to 3.2.  The forecast sales growth from Take Stock TSSW front page is 9.8% with 5 year future sales of $94,147M (see slide 1).

Value Line estimates annual growth of Sales per Share to be 12%. (This is from the “Annual Sales” chart on the left side of the report.) Predicted sales from the statistical array data on the VL report (11^th line under the chart) is $80,000M by 2011 to 2013. If I assume that in the middle year, WAG will have $80,000M in sales, growth will be at 7.9% annually. (see slide 2)

Implied growth is 11.9%. (Remember that implied growth is calculated by multiplying the Co. ROE by 1 minus the Pay Out Ratio.) For WAG I used the future numbers provided by VL. (ROE=15;POR=.21 15X.79=11.9.) Desired growth for a Co. this size is 7%.

Management guidance for WAG is not as “colorful” as other publicly traded companies. This has gotten more noticeable with the recent slow down in the economy and the inability of the Co. to guide into the future.

No guidance has been provided for Retail Sales. In an attempt to get some insight into future sales, I have broken out FE sales (Non Prescription medications, health and beauty etc) from prescriptions.

The Co has stated that 66% of retail sales are prescriptions. 95% of prescriptions are paid for by 3^rd party insurers, so that part of the business should be stable. Comps for prescription sales has been trending slightly lower. My judgment for future prescriptions comps is 3.5% growth in 2009. (see slide 3)

FE sales are also trending lower. (see slide 4) This has been more severe in the past 4 months with the slowing economy. Because FE includes Consumer Staples, I have predicted comps for 2009 at just 1%. (That may even be too high!) 2010 will hopefully bring economic growth and better FE sales. (FE sales offer the best margins for the Co.)

WAG will open 495 new stores in 2009; the average revenue for the 1^st 12 months of a store opening is $3.5M. The number of new store openings is going to slow (425 stores in 2010 and 355 in 2011) to the point where square footage in the stores will increase by only 5% in 2010 and from that year forward.

Finally, the Co. has stated that 6% to 7% of all sales come from Specialty Pharmacy and Wellness clinics, and that aspect of the business is expected to grow by15% to 20% a year.

Combining all these figures: Prescription comps of 3.5%, FE comps of 1%, 495 new stores and 15% growth of specialty pharmacy, I get sales of $62,806M or 6.4% in 2009. Starting in 2010, with a turn around in the general economy, FE sales should improve and I am predicting sales growth of 7.5% during the next 4 years. (Starting in 2010, FE comps of 3% and Pharmacy comps of 4.5%.) That makes the overall sales growth rate 7.3% per year for the next 5 years.

In my judgments, I used overall growth of 6.4% for 2009, and 7.5% each year after that. That gives me sales growth of 7.3% over the entire 5 years (which compares to 7.9% from VL) and total sales of $84,000M (which compares with about $86,000M from VL). These numbers are judgments with the available data. Your judgments may be different. Please let me know what you think.  

Sales growth for CVS has not been as steady as it has been with WAG. Sales growth has trended higher because of acquisitions made by CVS. Plotting trends for CVS is somewhat challenging due to the acquisitions. It acquired Eckard in 2004 and Sav On in 2006. Before these acquisitions, sales growth was steady at 11%. Sales growth after these 2 acquisitions increased as expected; for the 8 years from 1998 to 2006, yearly sales averaged 13%. Caremark was acquired by CVS in 2007 and sales jumped 74% that year. Interesting though, sales growth since that acquisition has cycled out (where we can compare Q to Q sales of CVS + Caremark, rather than comparing CVS one Q to CVS + Caremark the next Q) sales growth has decreased to 2%.

During the last recession, sales growth decreased to 8.3% in 2001. It rose to 10% in 2002 and to 15% in 2003.

Checking Online Take Stock for CVS, the growth screen shows the predictability of Sales and Earnings is rated 6.3. The forecast sales rate from TSSW page 1 is 14.4%, with sales in 5 years of $149,661M. That future sales figure has a starting total of $76,330M. The total sales from the last reported Qtr. was $85,272M. Projecting 14.4% growth for 5 years starting with $85,272M gives 5 year total sales of $167,085.   (Remember that this is based on past sales.) (see slide 5)

Value Line estimates Annual Growth of Sales per Share to be 9%. Predicted sales from the statistical array data is $112250M in 2011 to 2013. If CVS has sales of $112250M by 2012, sales would increase by 6.75% from today’s value. (see slide 6)

Implied growth is 10.7% (ROE=12%; POR=11%) using VL future values. Desired growth for a Co this size is 7%.

Management guidance for sales growth is somewhat better than what is provided at WAG. Guidance was last updated in 3-08. New guidance will not be provided until the Co reports it’s year end results in 2-09 or 3-09. At this point, because of the economic slowdown we are currently in, I am going to use the lower end of the guidance given by management. I am sure the Co will provide a better assessment with the year end report.

Same store sales for this past Qtr. (Qtr. 3 08) was 3.8% in pharmacy retail sales, and 3.3% in Front End sales. (Total retail same store sales was 3.7%.) 68% of retail sales are for prescriptions, of which 96% are paid for by insurance companies. I feel that revenue should be consistent, while a drop in FE sales will likely occur due to the economic downturn. (I will use the same judgment for FE sales at CVS as I did with WAG; 1% same store sales for 2009.) Retail store guidance for the 4^th Qtr. is 3.5% to 5%. (see slide 7)

Pharmacy services was guided to increase by 15% to 20% for 2008. Growth in this area has not been nearly as high as predicted by management, and in the past Qtr it has actually decreased by 1%.

New store openings will slow slightly; management has stated that square footage will increase by 3.5% a year into the future. New store openings account for 140 to 160 basis points of the total net revenue.

Combining same store retail sales, pharmacy services increases and the opening of new stores, I get sales growth for the next year of 7.2% totaling $91441M.

I have judged the Future Growth of the Retail Stores at 3.0% for 2009. This assumes prescription growth of 3.8% and FE growth of 1%. I have also judged Pharmacy Services growth at 10% which is less than guidance due to recent poor growth. Starting in 2010, my assumptions will be at the lower end of Co. guidance: 3.5% Retail Store growth, 15% Pharmacy Services growth, and 150 basis point growth from new stores. That gives growth of 9% for years 2010 to 2013. The 5 year average annual sales growth rate is 8.6%, which compares to 6.75% from VL. Sales growth at 8.6% a year gives total sales of $128,791M by 2013, which compares to VL predicted sales of $119,546M. 

To summarize sales growth for WAG and CVS: Both have had strong and consistent growth in the past, however, that growth is lower than past years. I have used future sales growth from management guidance on my SSG. These judgments are quite subjective. Please look them over and offer any other opinions.

FUTURE SALES GROWTH CHOICES

* 5 year sales growth prior to acquisitions made in 2004, 2006 and 2007.

In this study, I made some assumptions of future sales growth for pharmacy and front end sales. Attached is the most recent data I could find for WAG and CVS pharmacy sales. (I am still looking for updated Information on front end sales.)

In my study, I assumed 3.5% pharmacy sales for WAG-that is the growth the Co. reported in October. I also assumed pharmacy sales of 3.8% for CVS. They reported sales of 4% in September.

I'll try to keep you posted as the comparable sales become public.

Pat Landers