Streetwise

Lauren Rudd

Sunday, April 14, 2013

Tactical and Strategic Asset Allocation Are Key

The heated rhetoric from Wall Street each time the subject of regulation is raised represents little more than a reflection of greed and political bias. Those who complain bitterly that regulations only serve to suffocate the ability of the Street to operate in an efficient and competitive manner are espousing ignorance, are clueless, or fervently hope that you are.

Further debasing the blanket of investment trust relied on by so many for financial security has been the uprooting of a complacency, now nothing more than a deluding fantasy, that share prices of quality companies would somehow always rise to the occasion.

One way to mend a tattered mantle of financial security is to actively manage your investments using both tactical and strategic asset allocation strategies. And while a strong dividend yield is certainly the preferential avenue of choice in today’s volatile environment, the potential for capital appreciation, sans dividends, can also make for a compelling story.

If the preceding prose has caused you to incur a bit of a headache, you just might find some relief at CVS Caremark (CVS), a chain of 7,525 retail pharmacies and more than 500 retail health clinics. CVS is also one of the nation’s largest pharmacy-benefit managers resulting from the $27 billion merger of CVS with Caremark in 2007.

A year ago when I wrote about the company, my earnings estimate for FY 2012 was $3.25 per share, with a 12-month target price on the shares of $52, for an 18 percent capital gain. In addition, there was an indicated dividend of 1.50 percent. So how did the company do? Earnings came in at $3.43 per share, well exceeding my forecast, while the shares recently closed at $56.96.

CVS operates three primary business units, retail pharmacy, pharmacy benefit management and retail health clinics. CVS’s sales are about 20 percent of all retail pharmacy sales in the United States and its stores are focused primarily on the sale of pharmacy products with about 68 percent of revenues coming from prescription drugs.

Over-the-counter drugs and personal care products along with a wide array of merchandise such as convenience foods, greeting cards, beauty products, and seasonal items make up the balance of retail store revenues. About 98 percent of prescription drug sales are paid by third-party managed care providers through prescription drug plans.

CVS's pharmacy management services provides such services such as discounted drug purchase agreements, formulary management, Medicare part D administration, specialty pharmacy, and mail-order pharmacy services. The pharmacy management business generates about half of CVS's total revenues. CVS operates 12 mail-order pharmacies and 31 retail specialty pharmacies.

CVS is selling at a forward earnings multiple of 12.92 times 2013 projected consensus earnings. It has a solid balance sheet with $1.38 billion in cash and a low debt burden of just 14.4 percent of total capitalization.

Furthermore, the Company has a history of consistent dividend increases with a 38.0 percent increase in the dividend earlier this year. Of greater interest is the fact that the shares of CVS are up 14.1 percent this year and the retail giant has a three-year average revenue growth rate 7.89 percent, along with a three-year dividend growth rate of 30.04 percent

Standard & Poor’s has a “Strong Buy” rating on the stock (5 out of 5 stars) and a 12-month price target of $62.00 per share which is significantly above today's price.

A discounted earnings model yields an intrinsic value for the shares of $62, utilizing a 15 percent discount rate and an 11.83 percent growth rate. The more conservative free cash flow to the firm model suggests an intrinsic value of $92 per share, using a discount rate of 7.02 percent, which is the Company’s weighted cost of capital. As stated earlier, the shares recently closed at $56.96.