In certain parts of the country, CVS drug stores are as omnipresent as Starbucks: You can stand on a street corner and see two or more within walking distance. Any time you see this many physical retail outlets you might think of a maturing company that’s on its way to market saturation.
But there’s a lot more to CVS than the retail stores where so many of us buy not only our medicine, but our toiletries, candy and magazines. And if you’re wondering whether the business might be a good investment, you need to scratch beyond the most public-facing part of its business.
Earlier this month, CVS Health (NYSE: CVS) reported first-quarter results that were pretty stellar. The company, which operates almost 8,000 retail drugstores and a wide range of pharmacy services for employers, insurance companies and unions, showed an 11.1% increase in first-quarter revenue, which reached $36.3 billion; and a 5.3% increase in operating profit. That’s pretty good for a business that’s most commonly associated with brick-and-mortar retail.
Pharmacy Services Stand Out
The truth is, CVS is brick-and-mortar and a whole lot more. In fact, the bulk of its revenue growth in the quarter came from its pharmacy services division, where revenues rose 18.2 percent to $23.9 billion.
Its retail pharmacy revenues, by contrast, rose 2.9% and same-store sales at its retail pharmacy rose a more modest 1.2%. While the company did not specify exactly how much its business suffered from the recent decision to stop selling tobacco products, it did disclose that front store sales – the part of the store that once sold cigarettes and still sells M&Ms, holiday decorations and basic food items – fell 6.1%.
So here we have a company that’s received quite a bit of attention for its bold decision to drop a key product from its stores, but seems to be easily absorbing the hit. It’s not that tobacco sales were insignificant. The key is that CVS is a pretty diversified company. Even though it eliminated a significant product category from its retail business, it’s been able to grow overall revenues at a quite robust clip.
A Lofty Price
For investors, there’s another reason for interest: CVS stock pays a $1.40 annual dividend.
So what’s not to like? Well, maybe the price. Clearly the market sees abundant potential in pharmacy services and some of that optimism has been built into the company’s stock price, which has a hefty price-earnings ratio in the range of 25. Compare that to the retail drug chain Rite Aid (NYSE:RAD), with a P/E ratio of less than 4.
The price-earnings ratio is a stat that often captures long-term outlook better than the current reality. But whenever you see a lofty P/E ratio, you need to ask yourself not only whether the business is a good investment, but whether it’s a good investment at the current price.
I think the future looks bright for CVS. Its strong fourth-quarter results extend a strong trend of growth for several years, and its focus on pharmacy services positions it to benefit from one of the country’s biggest growth industries: health care. There’s likely considerable more room for CVS stock to grow. But higher-priced stocks do bring higher risks as well, and investors should be aware of that risk.
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