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Pharmacy Picks for the Value Investor

Highlighting two quality opportunities in the rapidly evolving drugstore sector.

Image via Mike Mozart/Flickr CC

John Buckingham, leading value investor, money manager and editor The Prudent Speculator, sees two quality opportunities in the rapidly evolving drugstore sector.

CVS Health (CVS) operates one of the largest domestic retail pharmacy networks with more than 9,600 locations and is also a leading provider of pharmacy benefits management (PBM) services.

CVS’s purchase of Aetna, which “fills an unmet need in the current health care system and presents a unique opportunity to redefine access to high-quality care in lower cost, and local settings,” has received shareholder approval, but still needs to pass muster with the Justice Department.

The PBM business is challenged, but with a whopping 1.78 billion adjusted claims processed in 2017, CVS has scale that gives it negotiating power to reduce branded drug prices for its customers.

While there is perpetual concern that Amazon (AMZN) will enter the retail pharma sales space, we don’t believe it will happen anytime soon, and we like that CVS offers numerous walk-in medical clinics and multiple client touch points as differentiators.

We also believe that CVS will benefit from growth in pharma product sales due to the aging of the U.S. population, with analysts looking for EPS to rise from $5.90 in 2017 to $7.30 in 2020. CVS will benefit from its tax rate dropping from 39% last year to 27% this year, and it generates strong free cash flow, which supports the generous dividend (the yield is currently 3.2%).

Despite delivering fiscal Q2 financial results that beat consensus estimates, shares of Walgreens Boots Alliance (WBA) finished the week slightly lower. The drugstore operator reported adjusted EPS of $1.73 (vs. $1.56 est.) on revenue of $33.0 billion (vs. $32.2 billion est.).

Generally, we were pleased with the results, given the ever changing operating pressures and the political gusts of wind that blow out of Washington from time to time, but we note that new pressure could be hitting WBA and its competitors as news broke a few days ago that Walmart (WMT) is in talks with health insurer Humana (HUM) about a range of business options that could include an acquisition.

The company raised the lower and upper ends of its guidance for fiscal 2018 and now anticipates adjusted diluted net earnings per share of $5.85 to $6.05.

This guidance assumes current exchange rates for the rest of the fiscal year and includes an expected benefit from the U.S. tax law changes that is marginally higher than the $0.35 per share upper end of the previously announced range.

While the Rite Aid locations may not materially impact 2018 results, we think that the added footprint will help the company reach a broader section of U.S. consumers and will give WBA the opportunity to take the battle to its competitors.

We also like the firm’s European footprint via its Boots stores in the United Kingdom, Norway, Ireland, the Netherlands, Lithuania, Mexico, Chile and Thailand.

Long-term, we believe WBA will benefit from robust growth rates on pharmaceutical products due to the aging of the U.S. and European populations, with analysts currently of the mind that EPS will climb from $4.97 in 2017 to $5.90 this year to $6.46 in 2019 and $7.11 in fiscal 2020.

WBA also generates solid free cash flow and we expect the dividend payout (the yield is currently 2.4%) to continue to rise. Our target price has been increased to $116.

John Buckingham is editor of The Prudent Speculator.

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