Drugstores can be an interesting sector for investors looking to position their portfolio in resilient businesses supported by strong secular tailwinds due to rising health care demand in the long term. Let's take a look at three prominent plays in the sector -- CVS (NYSE:CVS), Walgreen (NASDAQ:WBA), and Rite Aid (NYSE:RAD) -- to see what they have to offer investors.
CVS for quality
CVS has followed a two-tiered approach to the business, positioning itself as one of the largest U.S. pharmacy retailers and also as a premier pharmacy benefit manager, or PBM. Vertical integration provides diversification and multiple growth venues for the company, and it also produces negotiation and scale advantages for CVS versus smaller players.
CVS has outgrown competitors like Walgreen and Rite Aid by a wide margin over the last 10 years, and the company has superior profit margins in the area of 6.3% at the operating level versus operating margins near 5.5% for Walgreen and 3.6% for Rite Aid.
The company reported third-quarter earnings on Nov. 5, and the business is clearly enjoying good health. Revenues in the pharmacy services segment increased 7.8% to $19.5 billion during the quarter and the retail pharmacy segment delivered a 5% increase in revenue to $16.3 billion. CVS produced an increase of 23.9% in adjusted earnings per share to $1.05, beating analysts' estimates for the quarter of $1.02 per share.
Investors searching for a sound and reliable play in the sector with an integrated and profitable business model should look no further than CVS.
Walgreen for dividends
Walgreen stock has risen by more than 80% over the last year, not the kind of slow and steady return you would expect from big companies in a conservative and mature industry like drugstores. The main reason for this uncommon gain is that Walgreen solved a complex dispute with Express Scripts that was costing the company access to the 90 million potential customers in Express Scripts' network.
Even after such a steep rise, Walgreen is trading at a forward P/E of 15.3 versus 14.18 for CVS and 15.9 for Rite Aid, so the company doesn't look overvalued when looking at earnings multiples. Furthermore, Walgreen pays a dividend yield of 2% versus 1.4% for CVS and no dividend distributions for Rite Aid.
Dividends may be one of the biggest advantages Walgreen has over other companies in the industry. The company has a rock-solid track record of dividend increases, as it has paid a dividend in 324 straight quarters -- more than 80 years -- and has raised its dividend for 38 consecutive years, including a 14.5% dividend hike for 2013.
This gigantic chain of 8,105 drugstores in 50 states is benefiting from long-term trends like an aging population, the generic drug wave, and a maturing store base. The dividend payout ratio is quite moderate, in the area of 44.5% of earnings, so investors in Walgreen have good reasons to expect growing dividends from the company for years to come.
Rite Aid for growth
With a market cap below $4.8 billion versus $57 billion for Walgreen and $77.5 billion for CVS, Rite Aid is by far the smallest company in the group. This has some disadvantages in terms of scale and financial resources, but it also means higher growth potential for Rite Aid when compared to CVS or Walgreen.
The company has implementing a remarkable turnaround during recent quarters by controlling costs and introducing more generic drugs to boost sales. This has materially increased profitability, and Rite Aid investors have benefited from an explosive gain of more than 290% in the stock price over the last 12 months.
Judging by results over the last quarter, Rite Aid continues moving in the right direction: The company reported net income of $0.03 per share in second quarter fiscal 2014 versus a net loss of $0.05 per share in the year-ago period. Adjusted EBITDA was $341.6 million or 5.4% of revenues compared to $218.7 million or 3.5% of sales in the previous year.
Management also increased guidance for the rest of the year based on stronger than expected performance, so things are looking good for the company in the medium term. With nearly 4,600 stores versus more than 8,100 for Walgreen and more than 7,500 for CVS, Rite Aid still has plenty of room for expansion if management continues streamlining the business and improving profitability.
CVS offers superior quality, while Walgreen is the dividend play in the sector. For those with a higher risk tolerance and looking for more upside potential, Rite Aid may be the way to go. Whatever the doctor orders, these drugstores can deliver.
Fool contributor Andrés Cardenal has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.