CVS's Prescription for Competition

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When I was a kid the drugstores were nothing like they are today. As a kid trailing my parents around, it was pure boredom. There was nothing in the store to look at besides creams, pills, sprays, and that dreaded corner with a wheelchair and crutches.

Fast-forward to the drugstores of today, which have bright lights and aisles and aisles of cool stuff. Food, magazines, office and school supplies, home items, photo processing, and even toys and sporting goods have become part of the store mix. The drugstore has effectively bridged the gap among the 24-hour convenience store, the grocery store, and the old 5 and Dime stores.

So much has changed in the drugstore industry, but the one constant has always been customer service. CVS (NYSE: CVS), which is now the leading drugstore chain following the recent acquisition of Eckerd from J.C. Penney (NYSE: JCP), now has the size to leverage its costs more effectively. With pressure from competitors such as Rite Aid (NYSE: RAD) and Walgreen (NYSE: WAG), and national discount retail chains with drug counters such as Wal-Mart (NYSE: WMT) and Target (NYSE: TGT), CVS made a smart move to get bigger and stronger (without sacrificing customer service). The integration of Eckerd should take about a year as the company closes underperforming stores in order to gain additional cost synergies.

Additionally, the company recently reported better-than-expected second-quarter earnings of $0.56 per share, which beat the consensus estimate of $0.54 and last year's earnings of $0.49 a share. The company credited its non-pharmacy sales with a major chunk of the improvement, proving that people are shopping for much more than their health in drugstores.

The company has taken a chance through its acquisition of struggling Eckerd, but I think the gamble will pay off. CVS shares, which are trading at 16 times the consensus 2005 estimate of $2.61 per share, appear to be relatively inexpensive when compared with the 24% growth that is expected next year. Competition might be the name of the game in the drugstore industry, but CVS appears to have written the right prescription.

Fool contributor Phil Wohl spent more than 12 years on Wall Street and now concentrates his writing on more fictional characters. He has no stake in any firm mentioned above.