CVS or Walgreens?

Malcolm Berko
Tue, 12 Feb 2019 21:00:00 -0800
Lifestyle

Dear Mr. Berko: I can't make up my mind whether to buy 500 shares of CVS or 500 shares of Walgreens. — PW, Wilmington, N.C.

Dear PW: CVS, which stands for Consumer Value Stores, began life in 1963 as a health and beauty aids chain with $863,000 in revenues. Based in Woonsocket, Rhode Island, CVS Health (CVS-$67) completed its $69 billion acquisition of Aetna in November. Aetna was the third-largest health care benefits company in the U.S., with $60 billion in revenues. And after all the elves, pixies and gnomes are found hiding in their respective coves and corners, the $69 billion purchase price could run a few billion dollars higher. Aetna was among the nation's leading health care benefits companies, serving 47 million Americans. It directed their activities to promote better-informed outcomes (medical, pharmaceutical, dental and disability plans, etc.) while increasing our health care costs significantly each year.
Updated: Wed Feb 13, 2019

Dear Mr. Berko: I can't make up my mind whether to buy 500 shares of CVS or 500 shares of Walgreens. — PW, Wilmington, N.C.

Dear PW: CVS, which stands for Consumer Value Stores, began life in 1963 as a health and beauty aids chain with $863,000 in revenues. Based in Woonsocket, Rhode Island, CVS Health (CVS-$67) completed its $69 billion acquisition of Aetna in November. Aetna was the third-largest health care benefits company in the U.S., with $60 billion in revenues. And after all the elves, pixies and gnomes are found hiding in their respective coves and corners, the $69 billion purchase price could run a few billion dollars higher. Aetna was among the nation's leading health care benefits companies, serving 47 million Americans. It directed their activities to promote better-informed outcomes (medical, pharmaceutical, dental and disability plans, etc.) while increasing our health care costs significantly each year.

CVS management and analysts believe that this outside-the-box move will change the character of CVS — that combining the nation's leading pharmaceutical retailer with the nation's third-largest health insurer will cause hosts of closefisted, cheeseparing, mingy decisions and confusion regarding CVS' important Medicare Part D business. Some of the concessions ordered by a court in the District of Columbia may initially flatten CVS' earnings. The resulting hiccups will be heard by an estimated 12 percent of the workforce who will be laid off.

The combination of Aetna (50,000 employees) and CVS (203,000 employees) creates a health care giant with over $250 billion in revenues, and in the coming dozen months, a lot of previously sacrosanct turf will disappear. A long-term investment (three to five years) might be worthwhile; it depends on how smoothly the Aetna and CVS people integrate their boundaries and responsibilities. Certainly, the deal faces a series of protractive burps and belches, with unnecessary management friction causing implementation delays. Observers think CVS' revenue momentum will slow in the next few years, and so will earnings growth. Management will spend too much time managing the progress of the merger, to the detriment of the revenue and earnings progress of CVS. Although, the board is using some of its substantial cash flow (estimated $10.60 a share this year) to increase the dividend to $2.40 this year from the $2 paid in 2017 and 2018. And $2.40 could become $2.60 next year and then $2.90 in 2021, which would be a fair dinkum dividend. At today's market price of $67, that would be a 3.1 percent yield — better than, though certainly riskier than, a three-month certificate of deposit! CVS' stock is down nearly 50 percent from its $113 high in the summer of 2016, and Morningstar, Credit Suisse, Ned Davis Research, UBS, Argus Research, Bank of America, CFRA, Thomson Reuters and Value Line are recommending its purchase.

Some would say your portfolio would be better served with Walgreens Boots Alliance (WBA-$71). WBA opened its first store at Bowen and Cottage Grove avenues in Chicago in 1901. Both CVS and WBA should be good market performers during the coming three to five years, but I believe that WBA — with higher gross margins (28 percent versus 17.5 percent), superior net profit margins (4.6 percent versus 3.7 percent), superior returns on shareholder equity (22 percent versus 16.5 percent) and a hugely lower debt (32 percent of capital versus 62 percent of capital) — is a better buy. WBA's management is working on a deal with Humana (HUM-$296), and the two companies are discussing holding an equity stake in each other, which suggests that an outright merger between the two is possible in the coming dozen to 18 months. Seems to me that WBA is doing just fine without a HUM in its portfolio. But WBA management did a yeoman's job with the Alliance Boots merger, and the consensus is that a HUM merger would be an even more comfortable fit to revenues, profits and dividends.

Still, it's difficult to choose WBA over CVS. Both are well-run companies, and each has a list of prominent brokerages recommending the stock. For that reason, I suggest that you consider owning 200 shares of CVS and 400 shares of WBA.