CVS Caremark After Earnings: Solid Returns Ahead

Source: CVS Caremark.

CVS Caremark (NYSE: CVS  ) reported sound financial performance for the first quarter of 2014, even if earnings came in below analysts' expectations. The company is outperforming competitors such as Walgreen (NYSE: WAG  ) and Rite Aid (NYSE: RAD  ) , both over the last several years and in recent months. However, when comparing valuation ratios for CVS Caremark versus Walgreen and Rite Aid, the stock looks attractively valued. CVS Caremark looks well positioned for solid returns in the years ahead.

Healthy performance
Sales during the first quarter of 2014 increased by 6.3% to $32.69 billion, marginally above Wall Street estimates of $32.54 billion for the quarter. Earnings per share came in below expectations, though, as the company made $1.02 in adjusted earnings per share versus an average forecast of $1.04 per share for the period.

It's worth noting that this still represents a big increase of 22.5% in adjusted earnings per share versus the same quarter in the prior year, quite an impressive performance for a big company in a mature industry such as CVS Caremark. 

Besides, CVS was affected by harsh weather conditions and a weak flu season during the quarter, and this had a transitory negative impact on performance.

Revenues in the retail pharmacy segment increased by a lackluster 2.7% during the quarter, with same-store sales growing 1.4%. While pharmacy same-store sales increased by 3.8% during the period, front-end same-store sales were 3.8% lower, and this was the weakest spot in the report.

On the other hand, the pharmacy services segment was remarkably strong, with sales growing by 10% to $20.2 billion during the quarter. This segment is not only important in terms of financial contribution for CVS Caremark, but it also has big strategic advantages for the company in areas such as vertical integration, economies of scale, and overall competitive strength.

CVS Caremark reiterated its guidance for 2014, with total sales expected to increase by between 5.25% and 6.5% and adjusted earnings per share forecast to grow by 10.25% to 13.75% during the year. In spite of a weaker-than-expected first quarter, management seems confident of the company's ability to deliver solid performance in the rest of the year.

Growth and valuation
CVS has materially outgrown competitors such as Walgreen and Rite Aid over the last several years, and the company continues to outperform according to recent financial reports.

CVS Revenue (TTM) Chart

CVS Revenue (TTM) data. Source: YCharts.

Walgreen announced a sales increase of 4.5% in March to $6.43 billion, and total comparable-store sales grew by 3.5% during the month, but Walgreen was also affected by an unusually cold winter that hurt front-end sales. Total front-end sales fell by 2.6%, while comparable-store front-end sales decreased by 3.4% during the month.

Rite Aid has been implementing a remarkable turnaround over the last several quarters, and the company is clearly moving in the right direction when it comes to streamlining operations in order to improve profitability. However, Rite Aid is no match to CVS Caremark when it comes to sales growth.

Rite Aid announced an increase of 0.7% in same-store sales for the month of March, as front-end same-store sales fell by 0.5% and pharmacy same-store sales increased 3.5% during the period.

However, Rite Aid has already announced sales for April, and performance was much more encouraging. Rite Aid delivered an increase of 5% in same-store sales during April; pharmacy same-store sales increased by 5.2% during the month, while front-end same-store sales showed a healthy rebound with an increase of 4.7%.

Improving front-end sales from Rite Aid bode well for CVS Caremark and Walgreen over the following months, as it could be indicating that the industry is moving beyond the negative headwinds produced by the unusually harsh winter.

In spite of its superior financial performance, CVS Caremark trades at a valuation discount versus both Walgreen and Rite Aid when comparing P/E ratios. CVS Caremark has a P/E ratio below 20, while Walgreen trades at a P/E multiple above 24 and Rite Aid at an even higher P/E ratio of almost 35.

Superior performance merits a higher valuation, so CVS Caremark is offering considerable upside potential from current levels.

Foolish takeaway
CVS Caremark delivered lower-than-expected earnings for the last quarter, but the company is still performing soundly, and management is confident in its ability to deliver according to guidance for the rest of the year. When compared against Walgreen and Rite Aid, CVS looks like an attractive option in terms of growth versus valuation, so the company looks well positioned to deliver healthy returns for investors.

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