This article has been updated to incorporate sale and leaseback transactions in the cash flow numbers.
CVS (NYSE:CVS) dispensed plenty of good earnings news in its third-quarter report last week. But the cash numbers look like a bitter pill to swallow.
Sales revenues rose 13% to $9 billion compared with last year's quarter, and operating income increased 39% to $438.9 million. Net income available to common-share holders came in at $249.2 million ($0.30 per diluted share) versus $181 million ($0.22 per diluted share) one year ago, a 38% jump.
The nine-month statistics went down pretty smoothly as well. Sales revenues increased 26% to $27.3 billion and operating income appreciated 28% to $1.4 billion. Net earnings for common-share holders were $807.8 million ($0.97 per diluted share) versus $652.8 million ($0.80 per diluted share) for the nine months, an increase of 24%.
Focusing on the income statement, CVS nailed the quarter. Double-digit growth rates are always welcome by investors, so you can bet there were a lot of smiling faces reading this report. Comps were decent enough, as well as sales for stores open a year or more, which rose 5.7%. This figure excludes the effect of locations shuttered due to hurricanes Katrina and Rita.
Fans of free cash flow (I'm one) will be disappointed, however. While earnings were great, free cash flow through the third quarter was nowhere to be found. CVS derived about $850 million from operations during the last nine months while spending more than $1.1 billion on property and equipment. Free cash is, of course, the font of share buybacks and dividend payouts, so investors understandably want to see as much of the green as possible.
CVS is investing money to expand its business and properly integrate its acquisition of more than 1,200 Eckerd drugstores. Considering that the pharmacy business has incredible long-term prospects (think aging population) and considering the earnings returns generated thus far, it's possible that investing today will produce free cash tomorrow.
However, if you look at yearly free cash flow results since 2002 and add back the proceeds from sale and leaseback transactions, you'll find these cash flow numbers are positive. At the end of 2005, management expects to generate about $500 million in cash flow, including the proceeds from store sales and leasebacks. Thus, with CVS averaging about $470 million in sale and leaseback transactions, its looks like the 2005 year end cash flow number is very dependent on better working capital management and those sale and leaseback proceeds. Right now, the market might be looking relatively kindly upon CVS's managerial prowess (as evidenced by this one-year chart), but investors should keep an eye on the cash flow situation and decide what it may mean for the future.
Nevertheless, CVS and competitor Walgreen (NYSE:WAG) are the giants of drugstore retailing. There's Rite Aid (NYSE:RAD) as well, but I'm not a huge fan of that company or its stock. As Stephen Simpson pointed out recently, Rite Aid is still rather weak. Investors, in my opinion, should focus on the two major brands in this sector. Again, though, always watch the health of the cash flows.
Here are some more articles on the drug retailers:
- Same Old Same-Store Story
- All Green for Walgreen
- Rite Aid Not Right Yet
- Check out the CVS discussion board.
Fool contributor Steven Mallas owns none of the companies mentioned. The Fool has a disclosure policy.
