If you are looking to get into pharmacy stocks, the temptation is to look at those with turnaround potential. These highly risky stocks supposedly have attractive returns that will compensate investors for the degree of risk they take on, right? Below, I review this proposition by focusing on the real numbers and facts behind Walgreen Company (NYSE:WAG) and Rite Aid Corporation (NYSE:RAD).
Walgreen in a stronger position
Walgreen Company (NYSE:WAG)’s latest acquisition of USA Drug from Stephen L. LaFrance Holdings cost the company $416 million, but contributed over $100 million in value in the company’s first fiscal quarter of 2013. The company’s capital expenditures may have gone up by 4.5%, but Walgreen Company (NYSE:WAG) still added over 230 new locations –140 from USA Drug — to its total count of 8,000. The company may not regain more than 40% of the lost Express Scripts customers that went to CVS Caremark Corporation (NYSE:CVS), but the Alliance Boots $6.7 billion investment made it a global pharmacy.
In addition, vaccine makers are seeing so much demand that they are reporting shortages in their inventories. This puts Walgreen Company (NYSE:WAG) in a strong position to flip its cash flow into advertising that wins back more customers.
Hedge with CVS?
However, Walgreen Company (NYSE:WAG) is underperforming the industry. CVS Caremark Corporation (NYSE:CVS) and Rite Aid Corporation (NYSE:RAD) have both reported strong results while Walgreen has shown soft front-end monthly same-store sales. And with the stock near its 52-week high and 63% above the 52-week low, a lot of the upside has already been factored into the stock price. It now trades at a 10% premium to peer CVS despite missing expectations.
CVS Caremark Corporation (NYSE:CVS), in my view, is more attractive than Walgreen. At 13.9 times forward earnings and a 14% forecasted growth rate, CVS Caremark Corporation (NYSE:CVS) is comparatively undervalued. The stock is up only 44% from the 52-week low — comparatively little.
I am also optimistic that CVS Caremark Corporation (NYSE:CVS)’s mid single-digit pharmacy sales growth will offset industry-wide weakness in front-end sales. All in all, Walgreen Company (NYSE:WAG) has more to lose with the proliferation of dollar stores, so I encourage hedging with CVS. In addition, compared to the drug retail average, CVS Caremark Corporation (NYSE:CVS) is forecasted for a 100 bps greater EPS growth rate over the next five years.
A turnaround stock?
Rite Aid Corporation (NYSE:RAD) is showing that it can successfully turnaround business. Free cash flow and EPS have come out ahead of expectations, and reignited investor interest. Recent free cash flow growth was 141%. And it’s not like the market has overreacted in pushing the stock from below $1 to just above $2.77 — the free cash flow yield is still incredibly compelling at 10%.