Is CVS' $2 Billion Buyback Good Medicine?

Buybacks are back! Despite talk of still-tight credit markets, Wall Street's back on the buyback bandwagon. Fellow Fool Anders Bylund took Netflix (Nasdaq: NFLX) to task today for doubling down on its 2009 share repurchase program and its newly announced program. Now I'm going to walk you through CVS Caremark's (NYSE: CVS) analogous proposal to repurchase $2 billion worth of stock, to see whether it deserves similar castigation.

We all know the background to this buyback story. CVS has embarked upon a high-profile feud with rival drugstore operator Walgreen (NYSE: WAG), as the two giants jostle for supremacy in the pharmacy benefits marketplace. Merits aside, the argument has damaged the share prices of both contestants, and CVS, at least, thinks now's a great time to capitalize on its share price weakness, to lock in future returns for its shareholders. Is it right?

As in past columns of similar stripe, our analysis boils down to two basic questions:

Can it pay?
Not right away, no. CVS has only a little over $1 billion in its cash kitty right now. Meanwhile, its "bills" box is full to overflowing with $11.4 billion in debt.  

However, with a little patience, CVS should be able to fulfill its pledge. Over the past 12 months, this company generated $1.8 billion worth of free cash flow, a number that's held pretty firm through the depths of the Great Recession. According to management, CVS is on track to grow cash flow "significantly," making ample funds available to complete the buyback over the next 18 months.

Should it pay?
Sadly, probably not. Or at least not at this price. Take a look at how CVS' valuation stacks up against its peers:

A surface-level examination suggests that the stock CVS aims to repurchase is fairly priced; its price-to-earnings ratio of 12.3 almost precisely matches analysts' forecasted 12.4% growth. Sadly, that's the kindest thing I can say about the valuation -- that it might be fair. Viewed with any kind of skepticism, the bull thesis quickly falls apart.

Valued by its vaunted free cash flow, CVS looks cheaper than Kroger or the basket case that is Rite Aid. Yet CVS' price-to-free cash flow ratio is twice the P/E, and adding insult to overvaluation, significantly higher than either archrival Walgreen or incipient drug vendor Wal-Mart.

Foolish takeaway
The harder I look at the numbers, the harder it is for me to support CVS' share repurchase plan. My advice: Don't assume just because CVS is buying its stock, that this is a good idea. You'll find much better bargains at Wal-Mart and Walgreen.