CVS Caremark has the momentum

Despite concerning news out of the eurozone, the pharmacy stock has been going strong.

By Jim J. Jubak Nov 11, 2011 7:32PM
Remember back on Oct. 27, when stocks looked like they might rally through the end of the year? I asked then whether it was time to go with the momentum or move to the sidelines and wait for a pullback.

Just two weeks later, the question seems downright silly. Not only have we had that pullback, but it’s hard to find any momentum in this market at all. (Or at least any momentum to the upside.)

I think there’s still a good chance for an end of the year bounce -- if only because the world isn’t coming to an end, even in Italy, and the markets were pricing that in on Wednesday.

But momentum? You know, where investors buy stocks that have moved up strongly because they think those shares will move up even more as other investors go chasing past gains? It’s just about impossible to find. (I’d argue that in a bounce, on the other hand, it’s the stuff that has sold off most strongly that tacks on the gains.)

Almost impossible, but not quite. There are a few pockets of momentum in even this current market, but they’re just not in the places that we usually look.

I don’t see momentum in technology stocks, for example. In fact, recently the technology-heavy Nasdaq has lagged both the Dow Industrials and the S&P 500. (Yesterday afternoon, as of 3:10 p.m. New York time, the S&P 500 was up 0.61% and the Nasdaq Composite was down 0.07%.)

Certainly not in financials. Commodities and raw-materials stocks aren’t going anywhere as long as the dollar looks so much more attractive than the euro.

But how about names such as Wal-Mart (WMT), Eli Lilly (LLY), and CVS Caremark (CVS)? In spite of all the scary news out of the eurozone, these stocks have been moving up and look like they're ready to break through resistance and party.

Let me rephrase that. Because of all the scary news out of the eurozone, these stocks have been moving up. Safety with growth and/or a solid dividend yield is back in fashion in the market.

You may have your favorites among this group. At the moment, mine is CVS Caremark.

This company has struggled to put together its core drugstore business (7,200 drugstores with No. 1 market share in 72 of the top 100 U.S. markets) with the pharmacy benefit-management service company (Caremark RX) it acquired in March 2007. Instead of the expected synergies, it sometimes looked like the deal was destroying value for shareholders.

But I think CVS Caremark has finally put it all together. In the just-reported third quarter, the company reported 12.5% sales growth, with growth in the drugstore unit at 3.8% and in the pharmacy benefit-management unit at 25.8%.

Earnings climbed by 8%, and at 70 cents a share were ahead of the Wall Street consensus of 67 cents a share. Operating margins fell slightly in the quarter to 5.9%, from 6.2% in the third quarter of 2010, but free cash flow soared to $1.5 billion from $903 million as a result of reductions in inventory (down by $855 million in 2011 to date) and improved efficiency in working capital.

CVS Caremark is deep into the pharmacy benefit-management selling season, with about 70% of renewals completed at a 99% retention rate. The continuing dispute between Walgreen (WAG) and Express Scripts (ESRX), a pharmacy benefit-management company with 60 million members, has put an extra $5 billion in business up for grabs in 2012. (The two companies are locked in a court battle over Express Script claims that Walgreen disparaged Express Scripts services.)

CVS Caremark didn’t give any guidance for 2012 in its most recent conference call. For the fourth quarter, the company projected growth in retail EBIT (earnings before interest and taxes) of 4% to 7% and of 14% to 18% in the pharmacy benefit-management business.

For 2012, Standard & Poor’s is projecting total sales to climb 6.1%. Improving margins (and a lower share count due to stock repurchases) will contribute to a 15% increase in operating earnings in 2012.

Credit Suisse projects earnings per share growth of 15.5% in 2012 and 14.8% in 2013. At the Nov. 10 closing price of $38.49, the shares trade at 14.6 times projected 2011 earnings per share, and at 12.6 times projected 2012 earnings.

I’m adding CVS Caremark to my Jubak’s Picks portfolio as of Friday. A target price of $45 a share by October 2012 seems about right to me. That would be a 17% gain from Friday's share price. The stock also pays a 1.3% dividend.

At the time of this writing, Jim Jubak didn't own shares of any companies mentioned in this post in personal portfolios. The mutual fund he manages, Jubak Global Equity Fund (JUBAX), may or may not own positions in any stock mentioned. The fund did not own shares of any stock mentioned in this post as of the end of September. For a full list of the stocks in the fund as of the end of the most recent quarter, see the fund's portfolio here. 

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