With Big Revenue Gains in the Past, Should You Still Own Pharmacies?

Shares of Rite Aid (NYSE: RAD  ) and CVS Caremark (NYSE: CVS  ) followed Walgreen (NYSE: WAG  ) higher after it reported strong monthly sales. Rite Aid and Walgreen in particular have led the industry to being one of the top performers of the last two years, but in looking at current growth trends, will the industry keep outperforming the overall market? 

What has driven stock gains?
Year to date, Rite Aid and Walgreen have posted stock gains of 65% and 29%, respectively, significantly outperforming the S&P 500 index's 5% gain. These gains further add to a year in 2013 when Rite Aid soared 265% and Walgreen added another 57%.

Last year, much of the gains were created from a continuation of the patent cliff, a period of five years where $130 billion in brand-drug sales lose patent protection, as generic drugs create higher margins. For Rite Aid, the introduction of new generics took it from the brink of bankruptcy to creating $249 million in net income last year and being able to restructure its stores with new technology.

As for Walgreen, it certainly benefits from new generic introductions, but much of its stock gains have been in connection to its investment in Alliance Boots and the assumption that it will acquire the remaining 55% stake in early 2015. As a result, Walgreen will likely move its operations to Europe, pushing its corporate tax rate from 35% to 21% and driving profits much higher.

The current driver of gains
With all things considered, 2013 was about profits and becoming more efficient by a number of means. Yet, in 2014 we are seeing substantial growth for these companies, and this despite a higher mix of lower-priced generic drugs.

For reference, you can see below how Rite Aid's and Walgreen's year-over-year monthly sales growth has played out.

2014 Year-Over-Year Monthly Sales Growth

 

Rite Aid 

Walgreen 

January

1.8%

3.7%

February

1.5%

5%

March

0.7%

3.5%

April

4.9%

7.6%

May

3.5%

6%

Clearly, Walgreen is growing significantly faster than Rite Aid, but it is also more expensive as an investment. Walgreen currently trades at 0.9 times sales versus 0.3 for Rite Aid, showing a large disconnect, in large part due to the differential in growth.

Nonetheless, both have shown significant improvements. For Rite Aid, it grew revenue just 0.5% last year, which conveniently includes January and February's strong performance. Albeit, Rite Aid's 2.48% average monthly growth in 2014 is far better than last year, and it's because of this growth that Rite Aid recently boosted full-year revenue guidance by nearly $1 billion above the consensus.

As for Walgreen, its 5.2% average monthly growth in 2014 puts the company on par to exceed analyst expectations for 5% revenue growth this year. This shows major improvements over a year in 2013 when Walgreen's revenue grew just 0.8%. Thus, it was the company's 16.3% increase in adjusted net earnings that pushed the stock higher in 2013, not growth.

CVS isn't performing bad either
In addition, Walgreen and Rite Aid aren't alone in producing strong sales figures in 2014. CVS has also performed well; the company reported earnings in May to show a 6.3% increase in revenue over last year. Like Rite Aid and Walgreen, CVS struggles with its retail division but has seen pharmacy carry the load, with a revenue increase of 10.3% in its first quarter.

With that said, the driving force of growth is pretty much universal throughout the space, and it includes poor consumer traffic but higher basket sizes and strong pharmacy sales/volume.

Final thoughts
Albeit, CVS has the fewest catalysts moving forward, and at 15.5 times next year's earnings, it's likely fairly valued. Yet, Rite Aid at 0.3 times sales still trades far below the levels of its peers, and with a profit margin of 1%, it still has room to become much more efficient. And speaking of efficiency, the Alliance Boots acquisition could drive hundreds of millions in additional annual profits for Walgreen.

With that said, it's never a bad idea to take profits, but as we look ahead, Walgreen and Rite Aid in particular are showing no current signs of slowing down.

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Apple's next smart device (warning, it may shock you

Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early-in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!


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