Streetwise

Lauren Rudd

Sunday, April 6, 2014

For Investment Headaches Try CVS

The heated rhetoric from Wall Street each time the subject of flash trading is raised represents little more than a reflection of greed and political bias. Those who complain bitterly that regulation of such activities 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 Wall Street offers up an equal opportunity playing field.

One way to mend your tattered mantle of financial security is to actively manage your investments using both tactical and strategic methodologies. 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 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 CVS in FY 2013 was $4.00 per share with a projected 12-month share price of $64, yielding a capital gain of 12.36 percent. So how did the company do? Earnings came in at exactly $4.00 and the shares recently closed at $74.86.

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.

During 2013, revenues increased 3.0 percent to a record $126.8 billion, with Pharmacy Services up 3.8 percent and Retail Pharmacy up 3.1 percent. Within the Retail Pharmacy Segment, same store sales increased 1.7 percent.

Adjusted earnings came in at $4.00 per share, with the unadjusted GAAP earnings from continuing operations coming in at $3.75 per share. Both numbers include a $0.04 gain from a legal settlement in the third quarter

The company generated free cash flow of $4.4 billion, while cash flow from operations was $5.8 billion.

Looking ahead, CVS confirmed its adjusted earnings guidance for the year ahead of $4.36 to $4.50 and GAAP earnings per share from continuing operations of $4.09 to $4.23. These 2014 guidance estimates assume the completion of $4.0 billion in share repurchases.

The company raised its 2014 free cash flow guidance to a range of $5.5 to $5.8 billion from $5.1 to $5.4 billion, and its 2014 cash flow from operations guidance to a range of $7.0 to $7.3 billion from $6.6 to $6.9 billion, reflecting the shift in timing of certain cash receipts to early 2014 from late 2013.

Interestingly, CVS has announced that it will stop selling cigarettes and other tobacco products by October 1, 2014, making it the first national pharmacy chain to take this step. However, the decision does not affect the company's 2014 guidance going forward.

CVS estimates that it will lose approximately $2 billion in revenues on an annual basis from the tobacco decision, equating to approximately 17 cents per share. The company has identified incremental opportunities that are expected to offset the profitability impact.

A discounted earnings model yields an intrinsic value for the shares of $84.66, utilizing a 15 percent discount rate and a 13.36 percent earnings growth rate. The more conservative free cash flow to the firm model suggests an intrinsic value of $98.42 per share, using a discount rate of 7.32 percent, which is the Company’s weighted cost of capital, and a revenue growth rate of 11.5 percent.