Fool.com: CVS Preps for 2000 (News) October 27, 1999

CVS Preps for 2000

By Dave Marino-Nachison (TMF Braden)
October 27, 1999

Today's more than 10% flop for shares of leading drugstore chain CVS (NYSE: CVS) looks like textbook Wall Street at first blush: A company posts strong growth numbers but fails to outdo Wall Street's analyst consensus and gets punished for it in the next session.

And that's almost certainly part of this equation. CVS turned in earnings of $0.30 per share, a nickel better than last year but "flat" or "in line" with the mean of the baker's dozen of guesses analysts gave First Call.

But some observers credited the fall to fears that future earnings could drop off as the company continues to invest in new stores, relocations, and its online and disease treatment businesses.

"We do see 2000 as a year in which aggressive investment will be possible and appropriate," admitted David Rickard, who came on as CFO in August, in a conference call. He's still comfortable with Wall Street's estimates for full-year 1999 and 2000 earnings.

Admittedly, some worry about a company's focus on growth into new industries is understandable. This is particularly true in the drugstore business, where margin growth is frequently measured in basis points instead of percentage points. But comments made by CVS officials during the call suggest that they are as in tune as ever to the nitty-gritty of being the nation's largest drug chain.

Some examples:

-- CVS continues to expand its presence in the high-margin photo services business, where it's adding photo centers armed with Kodak machines that allow customers to edit and order photographs on the spot without a negative. In the third quarter, photography sales rose 27% from last year, a bonus since they're about 10 times as profitable as the company's full-line business on a gross-margin basis;

-- In a group of test markets with about 1 million people participating, CVS is finding that a relationship marketing program using customer cards is resulting in increased customer loyalty, but the company isn't jumping in just yet. Look for an update early next year, when the company hopes to better discern whether increased loyalty also means increased profits; and

-- The integration of Arbor Drugs has been going well not only from a sales and store growth perspective, but operationally as CVS executives say they have benefited from Arbor's expertise in front-end merchandising. It's good to see a company, especially one as large as CVS, finding multiple ways to parlay acquisitions into increased operating efficiency. In Q3 the company saw strong sales in its photo, beauty, and general merchandise segments in part because of this.

So what should investors make of the stock's slide today? Probably nothing. CVS' third-quarter performance was solid. Revenues rose 14.9% from 1998, while gross, operating, and net profits showed year-over-year improvement as well.

On the balance sheet side, Rickard said the company generated $77 million in free cash flow in Q3 and is "on track" to reach its internal full-year goal of $150 million; perhaps the only factor that could derail that projection is the delays Rite-Aid's (NYSE: RAD) PCS Health Systems pharmacy benefit management subsidiary has been reporting in making reimbursements. However negotiations between the companies work out, though, Rickard asserts CVS "will still have significant free cash flow in 1999."

The CFO also said to expect full-year sales growth of about 16.5%, with strong growth in both the pharmacy and front-end businesses, and October same-store sales growth of 11% or more with an eye to a full-year number of approximately 12%.

All told, he suggested, "This should place us at the top of our peer group as it relates to our ability to deliver value." It sounds like a pretty good call, and investors looking for a company focused on steady growth and profitability might want to consider CVS -- especially considering today's move.

Related Links:
CVS Investor Area
CVS Message Board

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