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A Drugstore is a Drugstore? No Longer, as CVS Outflanks Walgreens

This article is more than 10 years old.

CVS Caremark (CVS) and Walgreens (WAG) run pretty interchangeable stores for anyone who needs to fill a prescription or buy shampoo. But about a year ago, the companies came to opposite conclusions about owning certain back-pharmacy businesses. CVS got it right. Walgreens is paying for its decision.

CVS Caremark Corporation Stock Chart by YCharts

That perk up in the CVS share price in early November came from a third quarter report showing a 7.3% year-on-year earnings gain, driven by a 26% revenue gain at Caremark, the company’s pharmacy benefits manager. PBMs negotiate contracts between insurance plans and pharmacies.

Walgreens, on the other hand, saw its own PBM as a distraction from running drug stores and sold it in March. That decision has put Walgreens’ normal pharmacy operations at the mercy of someone else’s PBM. A dispute with Express Scripts Inc. (ESRX) likely means that Express will not list Walgreens as a qualified filler of prescriptions for the plans it manages. That will cut Walgreens’ overall pharmacy sales next year, according to its own early November announcement.

Express Scripts is a particular bad choice of enemies for Walgreens, as it’s already the third-largest PBM in the country and plans to merge with Medco Health Solutions (MHS), one of its biggest competitors. And if Express Scripts does write off Walgreens, it will need to give its clients another convenient, national drug store chain as an alternative. In other words, Express Scripts may end up sending former Walgreens customers straight to CVS. Because prescription customers tend to buy toothpaste and Motrin too, CVS stands to take a lot more from Walgreens’ than just pharmacy business.

The relationship with PBMs may ultimately be more important that general economic conditions -- think the unemployment chart and the U.S. GDP chart -- that traditionally drive retail results.

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The situation helps vindicate CVS’s decision to hang onto Caremark, which was still looking like the deal from hell as late as last year. CVS spent $2.1 billion to buy Caremark in 2007, then spent quarter after quarter explaining missed projections and lost contracts before the latest results showed $4.8 billion in new business. CVS still has to prove that all the new business it’s drumming up for Caremark won’t unduly squeeze profit margins, but those still look strong next to is biggest competitor.

CVS Caremark Corporation Operating Margin TTM Chart by YCharts

For investors, the new reality means CVS and Walgreens are no longer the interchangeable businesses they have been in recent years. CVS’s growth will be focused on the billions of dollars in PBM contracts that Caremark finally looks ready to pursue. Walgreens’ growth will be limited to the sort of cost cutting initiatives and health and wellness programs its competitors also seek, and perhaps by building up its online pharmacy, drugstore.com.

That change already is reflected in the CVS share price, which for the first time in several years is more expensive than Walgreens.

CVS Caremark Corporation PE Ratio Chart by YCharts

Walgreens may have a difficult time keeping shareholders happy in this new world. Its dividend yield of 2.73% beats CVS’s (1.28%), but it’s hardly the stuff of dividend investing. CVS’s Caremark, the unit that looked so doggy for so long, now looks like a great vehicle for turning a mature store chain into a growing company again.

Dee Gill is an editor for the YCharts Pro

Investor Service which includes professional stock charts, stock

ratings and portfolio

strategies.