Tuesday, April 6, 1999
DJIA 9944.06 -63.27 (-0.63%) S&P 500 1315.30 -5.82 (-0.44%) Nasdaq 2563.76 +3.70 (+0.14%) Russell 2000 402.08 -0.21 (-0.05%) 30-Year Bond 95 31/32 +27/32 5.53 Yield

An Investment Opinion
by Alex Schay

Market Not "Egg" Cited by CVS Sales

In ancient Egypt and Persia, decorated eggs were exchanged among friends at the spring equinox. Later, Christians of the Near East adopted this tradition and the "Easter egg" was transformed into a religious symbol -- purported to represent the tomb from which Jesus emerged, and often colored red to represent the blood of Christ. Today, however, consumers buy chocolate eggs from drugstore chains like CVS Corp. (NYSE: CVS) -- and apparently this season, they bought a whole heck of a lot of them. Forget the religious symbolism and stimulate the anandamide, CVS reported a 16.9% increase in same-store sales for the five-week period ended March 27 (although at least 10% of its stores are not included in the figure). The firm also reported that total sales for the 13-week period ending on the same date increased 17.7% to $4.24 billion, compared with $3.60 billion in 1998. Despite the big numbers, CVS was only up $5/16 to $44 13/16 this morning.

The company stated that pharmacy same-store sales rose 22.3% and total pharmacy sales represented 60% of total company sales in March (about 200 basis points higher than the percentage for the 1998 year). One would think that a higher percentage of drug sales in the mix would boost the bottom line; well, it ain't necessarily so. If they could just sell billions of greeting cards, business would be great. What many investors don't realize is that some drug retailers derive a significant amount of their pharmacy business from third party payor programs; that is, many chain drug stores own a pharmacy benefits manager (PBM) -- like PCS, Inc., which is owned by Rite-Aid (NYSE: RAD) and PharmaCare, which is owned by CVS. In 1998, about 85.4% of Rite-Aid's pharmacy sales were derived from third party prescription revenue, and 84% of the CVS pharmacy sales were derived similarly.

Although managed care providers have made the cost of prescription drugs more affordable to a greater number of people (thus expanding the market) and supported prescription drug therapy as a preemptive strike against more expensive forms of treatment, such as surgery, they also have a tendency to demand lower and lower plan costs from PBMs -- which hurts PBM margins. CVS has a "minimum margin policy" with regard to this aspect of its business and has noted on numerous occasions that it has had to turn away third party payors that do not meet its profitability requirements.

Overall though, the drugstore business is based on location and convenience, and taking a page from the Walgreen operations manual CVS has stated that it ultimately plans to have 70-80% of its stores in freestanding sites (23% of the existing stores are freestanding and it plans to boost this to 35% by the end of 1999). Why suffer the strip mall competition? Trading at 25 times 1999 numbers CVS is less expensive than Walgreen Co. (NYSE: WAG) -- although Walgreen's cash profile allows it to fund expansion from operating cash as well as generate a nice 13% return on invested capital. CVS certainly isn't undervalued, but if it can generate an additional $30 million in cost savings in 1999 from the Arbor Drugs merger (as planned) and continue the positive top line trends through effective merchandising, it should keep pace with the market.


Wireless phone company Nextel Communications (Nasdaq: NXTL) advanced $3/16 to $39 13/16 following reports that it's in preliminary talks to be bought by telecommunications giant MCI WorldCom (Nasdaq: WCOM). Some involved put the odds of a deal at no more than 50%, as the two phone companies have yet to reach agreements on key terms, including price, according to The Wall Street Journal. Shares of Nextel have risen of late on speculation of a deal with MCI WorldCom or another company. MCI WorldCom shares lost $3 7/16 to $89 1/16 today.

Speech recognition software developer Lernout & Hauspie Speech Products NV (Nasdaq: LHSP) added $5 1/4 to $43 1/8 after announcing that chip maker Intel Corp. (Nasdaq: INTC) agreed to invest $30 million in the company. Last month, Microsoft (Nasdaq: MSFT) increased its stake in Lernout to 7% after first buying an interest in September 1997.

Liberty Media (NYSE: LMG.A) rose $1 15/16 to $57 13/16 after News Corp. (Nasdaq: NWS), Rupert Murdoch's entertainment and media empire, announced a deal with its longtime partner to buy the 50% of Fox/Liberty Networks it doesn't already own. In exchange, News Corp. will give Liberty Media, a newly acquired unit of AT&T (NYSE: T), 51.8 million non-voting News Corp. American depositary receipts (ADRs) valued at about $1.425 billion, which Liberty has agreed not to sell for at least two years. For more on this development, return to this morning's Breakfast With the Fool.

TCI Music Inc. (Nasdaq: TUNE), meanwhile, which provides audio and video music services to commercial and residential consumers, raced ahead $11 13/16 to $20 3/16 after Liberty Media offered to give its Internet and interactive television assets and a $50 million loan to TCI in exchange for about 129 million shares of the company's class B stock, worth approximately $7.2 billion as of yesterday.

Microwave and radio frequency wireless communications products maker Alpha Industries (Nasdaq: AHAA) heated up $4 3/8 to $23 1/8 after announcing last night that it received "multiple design wins and increased production orders" from Motorola (NYSE: MOT) for integrated circuits and semiconductors to be used in cellular phones.

Streaming media leader RealNetworks (Nasdaq: RNWK), rated new "buy" at Donaldson, Lufkin & Jenrette with a $250 per share 12-month price target, picked up $31 1/8 to $185 5/8 this morning.

Airline operator Amtran Inc. (Nasdaq: AMTR) rose $1 1/8 to $19 5/8 after CEO John Tague said, "the Company's performance has continued to exceed our expectations so that it is now unlikely that the company would elect to proceed with an equity offering of primary shares during 1999.'' Tague made the comment in a statement in which he said the company will modify a shelf registration with the SEC; Amtran will also complete a 250,000 share buyback and consider further repurchases.

Propane service center company National Propane Partners (NYSE: NPL) took $4 1/4 to $11 1/16 after Columbia Energy Group (NYSE: CG) subsidiary Columbia Propane agreed to buy the company's 6.7 million outstanding common units for $12 each, a 76% premium over yesterday's closing price. Columbia Propane also plans to acquire Triarc Cos.' (NYSE: TRY) interest in National.

Hotel real estate investment trust (REIT) Sunstone Hotel Investors (NYSE: SSI) brightened $1 5/16 to $8 7/8 after announcing the receipt of an offer to buy the company from a group including CEO Robert Alter and New York opportunity fund Westbrook Partners, a 9.6% owner whose managing principal, Paul Kazilionis, is a Sunstone director. The offer would pay Sunstone shareholders between $9.50 and $10 in cash, at least a 40% premium to yesterday's closing price.

Coffee roaster and retailer Starbucks (Nasdaq: SBUX) roasted up $1 5/8 to $32 7/16 after reporting that same-store sales for the five weeks ended March 28 increased 6% year-over-year. Comparable-store sales for the 26-week period ended March 28 rose 5%.

Home-decorative accessories and collectibles maker Media Arts Group (NYSE: MDA) wrapped up $5/8 to $10 9/16 following the announcement that it plans to "develop an innovative Internet-based retail management information system and e-commerce presence." A conference call replay is available online at vcall.com.

Telephone network and call management products company Cognitronics Corp. (AMEX: CGN) rang up gains of $7/8 to $9 3/8 after announcing a pact to sell its McIAS 16xx specialized voice information services products to Lucent Technologies (NYSE: LU).

Home construction and mortgage financing company NVR Inc. (AMEX: NVR) added $2 to $43 15/16 after announcing that it expects Q1 EPS to be at least 30% above $1.45, the high end of the range four analysts gave First Call. The current consensus estimate is $1.37. New orders were 12% above last year's figure. The company expects to report results during the week of April 19.


Razor blades and batteries maker Gillette (NYSE: G) was nicked for a $7 5/16 loss to $50 7/16 after saying a "mid-single digit increase" in EPS and a "low single digit" rise in sales will result in Q1 earnings a penny below the current First Call mean estimate of $0.25. The company forecasted that international sales will rebound by Q3, allowing it to return to its historical EPS growth rate of 15% to 20% during the second half of the year.

Semiconductor automated wafer processing equipment maker Silicon Valley Group (Nasdaq: SVGI) slid $5/8 to $12 15/16 after saying production delays and sub-optimal customer timing for its lithography products will result in Q1 sales 30% below the $85.5 million reported a year ago. On the bright side, the company said bookings for its lithography products during the quarter were at "the highest rate in over one year," which should produce second half revenues "significantly higher" than those recorded in the first half of the year.

Discount retailer Ames Department Stores (Nasdaq: AMES) fell $1 9/32 to $34 7/32 after filing a registration statement with the Securities and Exchange Commission to sell an unspecified amount of common shares in a secondary offering, with the hopes of raising $100 million in proceeds.

Automobile transportation and logistics company Allied Holdings (NYSE: AHI) stalled $2 7/16 to $6 15/16 after saying an increase in light truck production by automakers is reducing the average number of vehicles that can be transported in one load, resulting in lower revenues since the firm is paid on a per-vehicle basis. The change in its delivery mix will lead to a Q1 loss between $3.5 million and $4.5 million, worse than analysts' estimates of a loss of $400,000.

Seismic data acquisition systems designer Core Laboratories (NYSE: CLB) was rocked for a $5 5/8 loss to $12 after saying continuing weak demand for its technology services will result in first half net income "significantly below" last year's levels. The company also said it will record $6.5 million in charges in Q1 for asset write-downs and layoffs, on top of a previously announced $3.5 million charge related to its failed merger with GeoScience Corp. (Nasdaq: GSCI).

Short line and regional freight railroads operator Genesee & Wyoming (Nasdaq: GNWR) derailed for a $2 3/16 loss to $9 1/4 after saying lower rail traffic and higher expenses will result in a worst-case Q1 loss of $0.07 per share. The sole analyst surveyed by Zacks had called for earnings of $0.40 per share in the quarter.

Building, aerospace, and industrial control systems designer Honeywell Inc. (NYSE: HON) was stuck with a $2 5/8 loss to $77 7/8 following a downgrade from Donaldson, Lufkin & Jenrette to "market perform" from "buy."

Pediatrix Medical Group (NYSE: PDX), which provides physician management services to neonatal intensive care units (NICU) in hospitals, lost another $3 7/16 to $13 11/16 after falling 36% yesterday on news that government officials in Arizona and Colorado are seeking billing-related information from the company. This morning, U.S. Bancorp Piper Jaffray and First Union Capital Markets both lowered their ratings on the firm.


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