CVS Caremark Beats, Then Falls. Should You Be Concerned?
CVS Caremark's (NYS: CVS) reward for posting stellar second-quarter numbers is a sell-off. Yeah, and not just any sell-off. CVS trading volume is over twice its daily average. After a record quarter, the reaction by investors may seem out of place. But there's more to this story, which is why Tuesday's drop isn't a surprise.
The good stuff
The $30.7 billion in revenues in Q2 set a new sales record for the $56.7 billion pharmacy health-care provider. And the 16.35% jump in revenues over last year drove a 25% increase in non-GAAP earnings. It's no wonder CEO Larry Merlo was "very pleased with our strong operating performance."
Same-store sales improved 5.6%, and CVS opened another 36 retail pharmacy outlets -- and closed eight -- during the quarter. Net cash from operations also jumped year to date, to $4 billion versus $3 billion last year. Both the pharmacy services and retail pharmacy units showed marked improvement, and management had every right to feel giddy. Capping off the good news for CVS is the new and improved revenue and earnings guidance for the balance of the year.
Four reasons for the muted reaction
After Walgreen (NYS: WAG) broke off relations with service provider Express Scripts (NAS: ESRX) last year, CVS captured many of its ex-customers. And why not? Taking advantage of your competitors' miscues is capitalism at its finest. But there's a problem. Now that Walgreen and Express Scripts have patched things up, CVS management plans on keeping 50% of ex-Walgreen customers. Retaining half the new customers is awfully optimistic. In fact, CVS included $0.05 a share in earnings from these folks.
A full quarter of revenue from April 2011's acquisition of Universal American's Medicare business raises the question of whether this is a true apples-to-apples comparison. CVS didn't state exactly how much UAM added to the recent quarter, but it was mentioned prominently in the earnings release. With UAM's $1.25 billion price tag, and an immediate doubling of CVS' existing Medicare business, this year's impact had to be significant.
CVS shareholders have enjoyed an 8% increase in share price year to date. Walgreen, until last month's meteoric rise, was down over 10% year to date. Rite Aid (NYS: RAD) , the third largest player in the industry, is struggling to stem losses and stay above penny-stock status. That kind of underperformance in the sector left investors with few options. And CVS shareholders already reaped the rewards, leaving the company fairly priced at current levels.
Now that Walgreen and Express Scripts have made up, another problem for CVS is the opportunity Walgreen offers investors. In addition to more stock price appreciation potential, Walgreen's 3.1% dividend yield is more than twice the 1.4% dividend yield CVS offers its shareholders.
In addition to the attractive dividend yield, Walgreen beats out CVS in several key financial areas. The impact of the new Walgreen and Express Scripts pact won't be felt until the third quarter.
Let's use the average of the recently provided upward earnings guidance CVS provided of $3.35 a share. At current share price levels, CVS is trading at just over 13.1 times projected earnings for 2012. Walgreen is trading at just over 12 times trailing earnings. Assuming Walgreen gets a year-end boost from the Express Scripts deal, the disparity is going to get bigger. Gross margins, return-on-assets, and return-on-equity numbers all favor Walgreen, too. And by a wide margin.
Bottom line is, CVS didn't do anything wrong; in fact, just the opposite. But questions regarding keeping its new customers and an apples-to-oranges comparison considering the UAM acquisition keep it from being my pick. For value and income in the retail pharmacy sector, to me Walgreen is the clear choice. There are a number of retail investment options, of course, in and out of the pharmacy sector. Many offer serious appreciation potential, but which are the best of the best? For a few ideas, take a look at our special free report "The Motley Fool's Top Stock For 2012."
The article CVS Caremark Beats, Then Falls. Should You Be Concerned? originally appeared on Fool.com.Fool contributor Tim Brugger currently holds no securities positions, including any mentioned in this article. The Motley Fool owns shares of Express Scripts Holding. Motley Fool newsletter services have recommended buying shares of Express Scripts Holding. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.