CVS' Tightrope Walk

These are interesting times for CVS (NYSE:CVS) and its shareholders. Over the weekend, Caremark Rx (NYSE:CMX) rejected an unsolicited takeover bid from Express Scripts (NASDAQ:ESRX), favoring a clearer future with CVS over more cash from its smaller rival.

This is good news for CVS, because the drugstore chain can't afford a protracted bidding war. Management is already stretched thin with the integration of Eckerd's and this past summer's acquisition of 701 Sav-On and Osco drugstores from SUPERVALU (NYSE:SVU). CVS also has used a significant amount of debt to pursue its growth objectives. The company is betting heavily that favorable industry dynamics will help it pull off its growth-by-acquisition strategy.

So far, the bet continues to work. In tandem with Walgreen (NYSE:WAG) and Rite-Aid (NYSE:RAD), CVS' total sales and same-store sales were up in December, with same-store sales increasing 8.5%. Pharmacy sales contributed a 10.4% increase, despite a shift in sales mix towards generic drugs, and front-end sales contributed a 5% increase. Combining same-store sales with the newly acquired Sav-On and Osco drugstores, total sales were up 24.2% to $5 billion from the prior December's $4 billion in sales.

Still, with strong sales and CVS' increasing scale, there is less room for error. CVS has to rely more on its operating profits to service its burgeoning $6.4 billion in debt. Rite-Aid attempted a similar strategy in the late 90s, but it nearly destroyed the company. (Seven years later, Rite-Aid is still nowhere near the competitor it once was.) So far, CVS's store acquisition strategy has proven successful, enabling the company to rival longtime leader Walgreen both in store count and now in sales.

Now toss in the potential merger with Caremark Rx. Just when CVS needs more than ever to train its focus on the productivity of its newly acquired store base, management will be increasingly turned towards the integration of the pharmacy benefits manager (PBM). While the CVS/Caremark combination should create value, management had best not lose focus on the continued profitability of its core business, which still lags Walgreen. Otherwise, CVS could be the next Rite-Aid -- not a pretty thought.

As an investor in CVS, I'm concerned that CEO Thomas Ryan and his team are overextending themselves and the company, but I'll take the recent sales as so far, so good. Which is to say, CVS is surely making it interesting; let's just not make it too interesting.

For related Foolishness:

• CVS Blazes a New Healthcare Trail
• CVS Sees Sales Rise: Fool by Numbers
• CVS/Caremark: A Brobdingnagian Drug Seller

Fool contributor Matthew Crews welcomes your feedback -- really! He has a financial position in CVS but in none of the other companies mentioned. The Motley Fool has a disclosure policy.