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Autor: anton 15 January 2011
Words: 3702 | Pages: 15
Part I Introduction and Financial Analysis
Both CVS Corporation and Walgreen Company operate retail drug stores in the United States. In addition to having pharmacies and selling prescription and non-prescription drugs both retailers also sell general merchandise. This includes items like beauty and cosmetic products, convenience foods, household items and film & photofinishing services.
Walgreens is the more established and older of the two companies. It was founded in 1901 and until recently it added stores from mostly internal organic growth. CVS is the newer company and started in 1963. The majority of growth at CVS has come from acquisitions of other companies like Revco, Arbor Drug, Eckerd and more recently Sav-On and Osco Drug Stores. Walgreens and CVS operate more than 5,000 chain stores each throughout the United States over 5,200 retail outlets each.
The major income statement changes for Walgreens the past two years are in the following areas. Net sales increased nearly $5 billion dollars from $37.5 billion in 2004FY to $42.2 billion in 2005FY while net income increased from $1.35 billion to $1.56 billion within the same period. It should be noted from Walgreens income statements the cost of sales increased 11% from $27.31 billion (2004FY) to $30.41 billion (2005FY). Selling general & administrative expenses rose from $8.06 billion in 2004FY to $9.36 billion in 2005FY.
On their balance sheet Walgreens showed an increase of assets in the following areas. Net property and equipment went from $5.45 billion in 2004FY to $6.17 billion in 2005FY a 13% jump. Inventories had an even greater percentage leap going from $4.74 billion to $5.59 billion over the two fiscal years or an 18% increase. Accounts receivable increased by more than $200 million or 19% Ð²Ð‚â€œ $1.17 billion in 2004 to $1.40 billion in 2005. A noticeable asset declining was short-term investments; it went down by 60% from $1.25 billion in 2004FY to $495 million in 2005FY.
In the area of liabilities and shareholdersÐ²Ð‚â„¢ equity the following significant changes occurred. Accounts Payable increased from $2.64 billion in 2004FY to $2.92 billion during 2005FY. Accrued expenses and other liabilities went from $1.37 billion to $1.49 billion over the same two fiscal years or a 9% increase. Other non-current liabilities increased at an even faster percentage rate (17%) from $850 million in 2004FY to $998 million. Retained earnings had a significant increase from 2004 to 2005. It went from $7.5 billion in 2004FY to $8.8 billion in 2005FY or a 16% change. In 2005 Walgreens also spend more on purchasing back their own stock ($515 million dollars) nearly 12 million shares vs. 2 million shares ($76 million dollars) in 2004.
As far as CVS their income statement had the following key changes in the past two fiscal years. Net sales grew over 20% from $30.59 billion in 2004FY to $37 billion during 2005FY while net income increased 33% from $918.8 million to $1.22 billion. On the expense side the cost of goods and selling general & administrative costs went up significantly as well. Cost of goods for CVS in 2004FY were $22.56 billion, while in 2005FY it was $27.11 billion a 20% increase. The general & administrative costs went up at 20% also from $6.08 billion to $7.29 billion or a 23% jump.
The balance sheet for CVS reflected an overall increase in net property and equipment from $3.51 billion during 2004FY to $3.95 billion in 2005FY. Total inventory increased from $5.45 billion to $5.72 billion in the two fiscal years. On the opposite side intangible assets went down from $867.9 million during 2004FY to $802.2 million during 2005FY or an 8% drop. Goodwill was another asset item that decreased from $1.9 billion (in 2004FY) to $1.79 billion (in 2005FY) or a 6% drop.
In the area of liabilities and shareholdersÐ²Ð‚â„¢ equity the following changes should be pointed out. Accounts payable increased nearly $200 million over the two fiscal years, going from $2.28 billion to $2.47 billion. Also moving up from 2004 to 2005 were retained earnings ($5.65 billion to $6.74 billion) and capital surplus $1.69 billion to $1.92 billion). Going in the opposite direction were two liabilities. Long term debt went down from $1.91 billion during 2004FY to $1.57 billion in 2005FY while accrued expenses dropped from $1.67 billion to $1.52 billion over the same period.
Both Walgreens and CVS are showing generally favorable news on their financial statements the past two fiscal years. Walgreens increase in sales and net income though not as accelerated as CVS is quite steady. Walgreens net sales have gone up nearly 13% while net income has increased about 16%. For CVS the increase has been more dramatic, net sales are up 20% between 2004 and 2005 while net income has gone up 33% during this time period.
Conversely the cost of goods and general & administrative expenses are increasing faster for CVS than Walgreens. CVS cost of goods and general & administrative expenses between the two fiscal years went up 20% (over $4.5 billion in COGS, and over $1.2 billion in G&A). This compares to an 11% increase in cost of goods ($3.1 billion) and 16% increase in general & administrative expenses
($1.3 billion) for Walgreens.
On total assets Walgreens is actually showing a larger percentage increase between 2004 and 2005 fiscal years than CVS. They went from $13.34 billion to $14.61 billion or a 9% increase in assets while CVS increased from $14.55 billion to $15.28 billion or a more modest jump of 5%. As far as liabilities and stockholdersÐ²Ð‚â„¢ equity Walgreens reflected an increase in both areas while CVS total liabilities actually decreased from $7.56 billion during 2004FY to $6.95 billion in 2005FY. This was related to decreases in accrued expenses ($145 million), notes payable ($632 million) and long-term debt ($338 million) by CVS. On shareholdersÐ²Ð‚â„¢ equity Walgreens went up a much smaller percentage than CVS, 8% ($661 million) vs. 19% ($1.44 billion).
An analysis of a few of the key financial ratios reveals the following:
RATIO 2005FY 2004FY
Return on Assets (ROA)
CVS 8% 6%
Walgreens 11% 10%
Walgreens is utilizing its assets more efficiently than CVS the past two years.
Earnings per Share
CVS $1.49 $1.13
Walgreens $1.53 $1.32
CVS earnings per share accelerated at a much faster pace than Walgreens between 2004 to 2005.
CVS 3% 3%
Walgreens 4% 4%
Walgreens has a better profit margin, earning approximately 4 cents for each dollar of sales vs. CVS which earns 3 cents for each dollar of sales.
Quality of Income
CVS 1.32 0.99
Walgreens 0.88 1.22
In 2005 CVS had a ratio over 1 which generally indicates high-quality earnings because each dollar of income is supported by one dollar of more of cash flow. Walgreens ratio under 1 usually represents lower-quality earnings.
CVS 6.47 5.61
Walgreens 7.55 7.92
Inventory turnover for Walgreens is better than CVS. In 2005 Walgreens had 48.3 average days supply in inventory (365/7.55) while CVS was much higher turnover at 56.4 average days supply in inventory (365/6.47). The good sign for CVS is that this was an improvement from 2004 when it averaged over 65 days (365/5.61).
In comparing the cash flows statements for both CVS and Walgreens it is interesting that both companies started and ended their 2005FY with basically the same amount of cash (start $392.3 million, end $513.4 million for CVS and start
$444 million, end $576.8 million for Walgreens). How their cash flow activity arrived at these ending cash positions was different though. At CVS net cash flow provided by operating activity was $1.61 billion vs. $1.37 billion at Walgreens. One of the significant differences between the two companies on operating activity was related to inventories. Walgreens spent much more cash on inventory in 2005 ($854 million) than CVS ($265 million). Another key difference was CVS outflow in account receivables was lower than at Walgreens $83.1 million vs. $225 million. Walgreens also spent more cash on accounts payable than CVS, it paid $277 million vs. $192 million.
For investing activity CVS net cash flow was -$911.6 million vs. -$434 million at Walgreens. Here CVS spent nearly $1.5 billion cash in property, plant and equipment while Walgreens utilized $1.2 billion. CVS also received less short-term investment proceeds than Walgreens ($552 million vs. $778 million).
On financing activity CVS had a net change in cash flow of -$579.4 million vs. -$804.4 million at Walgreens. Here the greatest difference between the two companies was in equity purchases. CVS received over $178 million in cash from exercising stock options while Walgreens paid $782 million in cash to buy back their common stock. The reason CVS had a net change for financing activity as a negative outflow was because of over $632 million they paid in cash to reduce short-term debt expenses. Walgreens did pay approximately $83 million more in dividends than CVS for 2005FY ($214.5 million vs. $131.6 million).
Below is a five year history of the stock prices for CVS and Walgreens. CVS is highlighted in blue and Walgreens (WAG) in red. Note the stock price for CVS has greater volatility; its share price has ranged 80% from high to low price while Walgreens range has been smaller at about 40%.
In the past year CVS moved quickly to a high from May to June 2005 when they announced a 2:1 stock split. The sharp decline in early October 2005 can be attributed to a CVS press release on October 6, 2005 in which the company narrowed its 3rd quarter guidance range from $0.29 to $0.31 to $0.29 to $0.30.
For Walgreens the share price has been steadier and less volatile though daily fluctuations can take place. An example just occurred on June 26, 2006. The share price moved up for both Walgreens AND CVS on a positive earnings press release from Walgreens. On this date Walgreens share price moved up over 1% ($0.49 per share) and CVS share price increased by over 2% ($0.63 per share). See partial news release from Reuters on Walgreens announcement from this date below.
Walgreen 3rd-quarter profit up, drug sales strong
Monday June 26, 2:25 pm ET
By Jessica Wohl
CHICAGO (Reuters) - Walgreen Co. (NYSE:WAG - News) on Monday posted a 14.2 percent rise in quarterly profit, aided by higher sales of prescription medications, and said it would look at more acquisitions as the drugstore industry consolidates.
Walgreen, the nation's largest drugstore chain by revenue, has been adding new stores to its lineup to fend off increased competition from rival CVS Corp. (NYSE:CVS - News), which has grown its own store base, largely through acquisitions.
Walgreen had 5,251 stores across the United States as of May 31 and plans to add 76 pharmacies to its lineup with the acquisition of the Delaware-based Happy Harry's chain, its largest acquisition in 20 years.Ð²Ð‚Ñœ
Part II Accounting Methods
Accounting methods between the two companies are fairly similar. There are a few key notes that I would like to review. Walgreens provided for nearly a
$55 million dollar charge of pre-tax expenses due to Hurricane Katrina. This hurricane forced the closing of 74 stores as well as considerable loss of inventory. CVS was not impacted by this hurricane since their stores are not concentrated in impacted area like Walgreens. CVS had a stock split during 2005. The shares were distributed on June 6, 2005 to shareholders of record as of May 23, 2005. On their 2005 annual report they restated all share and per share amounts to reflect the effect of the stock split. Walgreens spells out its stock repurchase program which it announced in July 2004. The program was to buy back their stock of up to $1 billion which they plan to execute over 4 years. This accounted for the sharp increase in treasury stock between the 2004 and 2005 fiscal years.
CVS uses the first-in, first-out basis (FIFO) to determine cost of sales and inventory in their stores. In contrast Walgreens uses the last-in, first-out (LIFO) method of inventory valuation. This is unusual considering both companies are in the same industry. Generally the LIFO method is more conservative and generates less income during a period of rising prices. However Walgreens does note in the past three fiscal years (2003-2005) they experienced Ð²Ð‚ÑšdeflationÐ²Ð‚Ñœ in some non-prescription inventories. Under liquidity section in their annual report Walgreens states on decrease in net cash provided by operating activities (over $270 million), Ð²Ð‚ÑšThe change between periods was primarily caused by net earnings offset by higher inventory levelsÐ²Ð‚Ñœ. One last comment from Walgreens annual report (pg 26) on inventories, they state Ð²Ð‚ÑšInventories are valued on a lower of last-in, first-out (LIFO) cost or market basis. At August 31, 2005 and 2005 inventories would have been GREATER by $804.2 million and $736.4 million, respectively, if they had been valued on a lower of first-in, first-out (FIFO) cost or market basis. Both CVS and Walgreens are similar in recognizing revenue at the time of the sale.
Both CVS and Walgreens use the straight-line method on depreciated assets like property, equipment and improvements to leased premises. There is a slight difference on what they determine PPE useful lives. For example CVS generally uses 10 to 40 years for buildings while Walgreens uses 12 Ð’Ð… to 39 years as their useful life. Goodwill and other intangibles are noted in the CVS annual report. They carry nearly $1.8 billion (2005FY) for Goodwill on their balance sheet related to recent acquisitions like Eckerd stores in 2004. CVS stated Ð²Ð‚Ñšthere was no impairment of goodwill during 2005Ð²Ð‚Ñœ. Basically they left the full amount on the books except for some favorable post-closing adjustments in their Acquired Businesses. Walgreens is carrying over far less in Goodwill and other intangible assets, their net total at the end of 2005FY was $84 million compared to $1.8 billion for CVS.
One interesting tidbit on the CVS accounting notes (number 10) related to the commitments and contingencies section. It seems CVS has prior store lease liability regarding sold or spun off subsidiaries like BobÐ²Ð‚â„¢s Stores and Linens Ð²Ð‚?n Things from the 1990Ð²Ð‚â„¢s. CVS would be obligated to pay off these leases if the purchaser/s/ were to become insolvent. CVS management estimates obligations could total as much as $450 million as of December 31, 2005.
Overall the accounting methods for CVS appear to be slightly more aggressive than Walgreens. They are utilizing the FIFO method on inventories vs. LIFO method by Walgreens. In addition they are carrying over a considerable amount of goodwill from the acquisitions they have made in the past few years. Lastly the potential liability amount of lease obligations CVS carries over from prior subsidiaries that were spun off or sold.
Part III Publicly Available Information
On May 4th, 2006 CVS issued the below press release (first two paragraphs):
Ð²Ð‚ÑšCVS Corporation Reports Record Sales and First Quarter Earnings; Net Earnings Increased 13.8%, While Diluted EPS Rose to $0.39
WOONSOCKET, R.I., May 04, 2006 (BUSINESS WIRE) -- CVS Corporation (NYSE: CVS), today announced record sales and earnings for the first quarter ended April 1, 2006.
Net earnings increased 13.8% to $329.6 million or $0.39 per diluted share, compared with net earnings of $289.7 million or $0.34 per diluted share in the first quarter of 2005.Ð²Ð‚Ñœ
CVS per share price went up from $0.68 the next day May 5th from $30.26 to $30.98, over a 2% gain. Just recently (June 2nd, 2006) CVS issued a press release on the completion of its Sav-On and Osco Drug acquisition (first two paragraphs):
Ð²Ð‚ÑšCVS Corporation Completes Acquisition of Approximately 700 Standalone Sav-On and Osco Drugstores; Gains Immediate Market Leadership in Fast-Growing Southern California Drugstore Markets, and Boosts Share in Key Midwest Markets
WOONSOCKET, R.I.--(BUSINESS WIRE)--June 2, 2006--
CVS is America's #1 Pharmacy, Now Operating Over 6,100 Stores
Across 42 States and the District of Columbia
CVS Corporation (NYSE: CVS), today announced that it has completed the acquisition from Albertson's, Inc., of approximately 700 standalone Sav-On and Osco drugstores and a distribution center in La Habra, California.
Tom Ryan, Chairman, President, and Chief Executive Officer of CVS Corporation, said: "This acquisition strengthens our position in key Midwest markets and provides an immediate leadership position in the fast-growing southern California markets. Our highly experienced team is already launching our comprehensive integration plan, and we welcome the talented Osco and Sav-On associates into the CVS family. We see significant, long-term strategic and financial benefits from the addition of these stores, and look forward to capitalizing on the many growth opportunities presented by this important acquisition."
Again the stock market was pleased with this news and the share price for CVS went up from $28.57 on June 1st to $29.24 on June 2nd, over a 2% gain.
I referenced earlier how Walgreens released an earnings statement on June 26th regarding its 14.2% earnings increase and record sales for their fiscal 2006 third quarter and how it had a dramatic impact on their share price as well as CVS. Earlier on June 5th, 2006 Walgreens issued the following press release on a new acquisition (first three paragraphs):
Ð²Ð‚ÑšHappy Harry's Pharmacy Chain to Merge with Walgreens
DEERFIELD, Ill., June 5, 2006 - Walgreen Co. (NYSE, NASDAQ: WAG) Chairman and CEO Dave Bernauer and Happy Harry's Inc. Chairman and CEO Alan Levin today announced that Delaware-based Happy Harry's pharmacy chain has agreed to a merger with Walgreens. Financial terms of the agreement weren't disclosed.
The transaction includes all 76 Happy Harry's stores in Delaware, Pennsylvania, Maryland and New Jersey, and the corporate office and distribution center in Newark, Del.
"Happy Harry's is one of the strongest regional chains in the drugstore industry with a great following in a market where we have little presence," said Bernauer. "Its brand reputation and market share are a great base from which to build our presence there. These stores are performing well and will benefit us right from the start."
In this case the investor community took the news and moved Walgreens per share price down from $42.65 on June 2nd to a closing price of $41.86 on June 5th (the press release went out that morning). A recent MarketWatch article appeared on June 26th with the following comment:
Ð²Ð‚ÑšThe company, which operated 5,521 stores as of May 31 compared with 4,837 a year earlier, said it expects to close on the acquisition of the 76-store Happy Harry's pharmacy chain in the coming weeks. Walgreen, already facing competition from
Wal-Mart Stores Inc. ( WMT47.63, -0.44, -0.9% ) , is also being pressured by CVS Corp. ( CVS29.25, -0.58, -1.9% ) , which now operates more than 6,100 locations following its acquisition in early June of about 700 Sav-On and Osco drugstores in the break up of Albertson's Inc.Ð²Ð‚Ñœ
You can see this author from MarketWatch is clearly inferring the acquisition of Happy HarryÐ²Ð‚â„¢s by Walgreens was in response to competitive pressure from CVS and Wal-Mart. Note there is a slightly different take by Walgreens CEO (David Bernauer) from their June 26th 3rd quarter earnings announcement:
Ð²Ð‚ÑœDuring the quarter, Walgreen announced a deal to buy the 76-store Happy Harry's Inc., a privately held regional drugstore chain based in Delaware. "We'll continue to evaluate other potential retail pharmacy acquisitions, but we'll pursue only those with a solid strategic fit, which are rare," Bernauer said.Ð²Ð‚Ñœ
Part IV Company/Industry Future Outlook
Both CVS and Walgreens are consistently growing sales and net income. CVS has been more aggressive in its growth through major acquisitions the past ten years most recently with the purchase of Albertsons Osco Drug and Sav-On stores. CVS is now clearly number one in total retail drug stores with over 6,000 U.S. locations. Analysts have a similar opinion on both companies. There are currently 15 buy recommendations for CVS and 16 for Walgreens. Yet CVS has a current market cap of about Ð’Ð… Walgreens ($24 billion vs. 45 billion). Why is that? I think there are a few reasons. First, Walgreens has been the top drug store company for many years. It has earned the respect of the investor community by decades and decades of continued sales and income growth. As even they note on their annual report Ð²Ð‚ÑšBarronÐ²Ð‚â„¢s magazine lists Walgreens as one of the top 10 Ð²Ð‚Ñšmost respectedÐ²Ð‚Ñœ companies in the worldÐ²Ð‚Ñœ.
Second, in comparison CVS has taken a far riskier approach to growth through acquisitions. This adds more financial debt at CVS as they are consistently buying other chains for cash, stock or a combination of both. It also puts added reliance on the share price at CVS. If there is a major market or industry correction then CVS will suffer more as they rely more on their stock to fund their continued debt obligations.
Overall the drug store industry appears to have a strong outlook. The baby boomer population continues to age and requires more pharmacy and over the counter medicines. This is where the drug stores gather their highest profit margins. They have been able to compete effectively with mass merchants like Wal-Mart by operating 24 hour pharmacies and even offering drive-thru services. In the case of CVS their card loyalty program has proved very beneficial in bring back customers to receive discounts on future purchases.
In conclusion I think both CVS and Walgreens are good investment opportunities. They continue to consolidate the industry through both acquisitions and internal growth and there is definitely a market for two strong drug store chains in the U.S. CVS might have a greater upside in the short-term but is a more risky purchase. In reviewing the financial statements and accounting notes you can see how CVS has relied very much on acquisitions to fuel its growth. If this slows down or stops then the CVS share price might suffer a sharp decline. Walgreens in contrast has shown double digit growth mostly through internal store expansion. If CVS is to slow down or stop their acquisitions then its internal growth might disappoint the investment community. I would invest some 401K funds (remember it is always best to diversify among different industries and asset classes) into both companies. My investment breakdown would be 65% Walgreens and 35% CVS for each dollar invested in the next five year horizon.
Part V Sources and References
1. CVS 2005 Annual Report (see attached financial statements and notes)
2. Walgreens 2005 Annual Report (see attached financial statements and notes)
3. YAHOO! Finance Website (www.finance.yahoo.com)
4. CVS Website (www.cvs.com)
5. Walgreens Website (www.walgreens.com)
6. Thomson Financial
9. DisclosureÐ²Ð‚â„¢s SEC Database