Investing
New York Times
By J. ALEX
TARQUINIO
Published:
September 10, 2006
Multimedia
But there is more to it than that, some analysts
say. In their view, the new Medicare drug benefit, as well as a rising tide of
generic drugs, may become a potent combination for drugstore profits, which are
likely to keep growing as the population ages.
“People are
looking for defensive investments now,” said Patricia A. Baker, a stock analyst
at Merrill Lynch who
is bullish on the industry. “Unlike the supermarkets, which are a recovery
story, we believe the drugstores are a long-term growth story.”
The drugstore
stocks are all up for the year. Shares of Rite Aid have
swung up and down on reports that the the company
planned to buy more than 1,800 drugstores in the
Under a deal
announced last month, Rite Aid will pay Coutu $1.5
billion in cash and assume $850 million of Coutu’s
debt in exchange for the Eckerd and Brooks stores. It plans to rebrand all of them as Rite Aid stores, bringing its total
number to about 5,000. Rite Aid would still be the third-largest drugstore
chain in the
Even before the
deal, analysts pointed out that Rite Aid had a lot of debt, the legacy of an
earlier accounting scandal. John Heinbockel, an
analyst at Goldman Sachs,
wrote in a note to investors last month that the merger would create “a much
larger, but still underperforming and highly leveraged company.” Although Mr. Heinbockel started recommending Rite Aid’s stock in March,
he removed it from his buy list once the deal was announced. Rite Aid shares
now trade at $4.34 , up 24.7 percent for the year.
Many analysts
say broad industry trends should particularly favor the two largest American
drugstore chains, Walgreen, based in
“They’re
defensive stocks at a time when their sales are accelerating,” said John W.
Ransom, an analyst at Raymond James & Associates in
As recently as
December, Mr. Ransom said, drugstore chains were widely viewed as a growth
industry. But he said growth in the number of prescriptions filled each year in
the United States peaked at 10 percent in 1999, then started decelerating
through the first half of this decade. In the fourth quarter of 2005, the
number of prescriptions actually declined, by about 0.5 percent from the period
a year earlier.
Mr. Ransom said
pharmacists started filling more prescriptions again this spring, in part
because of the new Medicare drug benefit, known as Medicare Part D, which went
into effect in January.
Quite a few
investors took notice, bidding up the stocks of major national drug retailers.
For the year to date, the gains have been roughly 15 to 35 percent.
While Medicare
Part D is likely to reduce the drugstore chains’ profit margins for individual
sales, it should increase their sales volume, analysts said.
For example,
Mr. Heinbockel said, the new drug benefit could help
the chains take back some business from discounters like Wal-Mart and Costco,
which appeal particularly to customers who have to pay for prescriptions out of
their own pockets. Some customers who have started receiving drug coverage
through Medicare — and now pay the same co-payments wherever they go — may
prefer to shop closer to home, he said.
The drugstore
chains may also pick up some business from small local pharmacies that do not
have relationships with all the insurance providers in the Medicare Part D
program. Independent pharmacies still account for about 18 percent of the
domestic market for prescription drugs, and Mr. Heinbockel
estimated that their share could be sliced in half over the next 10 years.
Drugstore profits
are also likely to benefit from a shift toward generic drugs, some analysts
said. Branded drugs with annual sales around $25 billion are set to come off
patent by year-end, according to Goldman Sachs. That works out to 300 million
prescriptions a year in the
The change
could put a big dent in drugstore sales while giving a huge lift to their
profits. That is because the sales price of a generic drug is usually a small
fraction of the cost of a similar brand drug, but a drug retailer’s markup can
be much higher. Mr. Heinbockel estimates that the
average markup on a brand-name drug is around $10, but that it’s closer to $14
for a generic.
Ms. Baker at
Merrill Lynch said that about two-thirds of the sales at CVS or Walgreen stores
were made by their pharmacies, “and that is probably the most predictable
stable piece of retail out there.”
SHE estimated
that CVS’s stock could trade at up to $40 by the end
of next year, which would be 22 times her estimate of $1.83 a share for the
company’s earnings in 2007. The stock closed at $35.50 on Friday, or 23.7 times
trailing 12-month earnings.
Ms. Baker also
said she thought that Walgreen’s stock could rise to $56 next year, or 27 times
her 2007 earnings estimate of $2.05 a share. (Walgreen’s uses a different
fiscal calendar, but Ms. Baker based her comparison of the two companies on the
2007 calendar year.) Shares of Walgreen now trade at $50.91, or 30 times
earnings over the last 12 months.
Stephen C.
Chick, a stock analyst at J. P. Morgan
Securities, recommends buying shares of Walgreen, but not those of the other
companies. He said the share-price increases this year probably already
reflected expectations for profit growth at both Rite Aid and Longs Drug Stores,
which is based in
Mr. Chick also
said he preferred Walgreen because it has focused on internal growth, while CVS
has relied more on acquisitions. For example, CVS bought a number of Eckerd
stores in 2004, when Coutu acquired the Eckerd stores
that it is now selling to Rite Aid.
The longer-term
case for investing in the drugstore stocks depends largely on the notion that
aging Americans will gradually be consuming more pharmaceutical products.
“If you’ve got
a customer and they take 20 prescriptions this year, chances are they’ll take
21 next year,” said Mr. Heinbockel at Goldman Sachs.
“It’s almost like an annuity business.”
