One thing might bring investors back to

J.C. Penney

(JCP) - Get Report

: drugs.

Or at least that's the pitch management is giving investors, who until recently shunned the company for its crumbling department store business. But judging by the stock's 90% rise this year, plenty of them are buying the new line.

The challenge is formidable: Penney's drug arm,


, faces stiff competition in the two juggernauts of U.S. drugstore retailing,


(CVS) - Get Report




. And while Eckerd's pharmacy business is growing nicely,

sales of so-called front-end products -- the snacks and other nondrug items that now account for the bulk of drugstore profits -- have lagged behind.

But Plano, Texas-based Penney plans to whip Eckerd into shape by remodeling many of its Northeast stores, shaking up the product mix, investing in technology and cutting costs by improving the supply chain. Considering the premium that rival drugstore stocks sport, Eckerd offers the patient investor a way to play the drugstore sector on the cheap, analysts say.

Vision Questrom

Allen Questrom, who whisked

Federated Department Stores


out of bankruptcy in the 1990s before being tapped last year to revive the fortunes of J.C. Penney, recently told a gathering of

Lehman Brothers

institutional clients at a conference in New York that Eckerd could be worth $9 billion to $11 billion within three years, about double Penney's current market capitalization. He made similar comments at the company's March analyst meeting.

Long Way to Go
J.C. Penney's plunge over three years

Penney, which lost money last quarter and saw earnings per share drop 90% last year, is increasingly pinning its hopes on a drugstore turnaround: At the Lehman event, for example, Eckerd Chief Executive Wayne Harris, a former supermarket executive who was tapped last year to run Eckerd, spoke first. Questrom began his remarks by talking up Eckerd as well. For its part, Eckerd, which J.C. Penney bought in 1996 and by its own admission didn't run well, lost about $600,000 last year on revenue of $13 billion.

"The fact is, this was a good company that was poorly run," Questrom told the Lehman gathering, explaining that Penney considered issuing a tracking stock for Eckerd last year but now will focus on its turnaround. He laid out projections: Eckerd plans to maintain annual comparable-store sales growth of 8% to 10% and within three years to report earnings before interest and taxes of around 4% to 4.5% of revenue, in the ballpark of industry norms and a return to Eckerd's 1997 levels. This would give the company about $1 billion in EBITDA, or earnings before interest, taxes, depreciation and amortization, a measure of cash flow Wall Street watches for capital-intensive businesses. It would also put the company third on the list of the country's largest drugstore chains, the slot the company says it is aiming for.

One money manager who began buying J.C. Penney stock last year when Questrom was hired because he believes in the CEO's track record of turning around beleaguered retailers, says third-best is good enough for him.

"Clearly, with Walgreens and CVS you are talking about the class of the industry," says Bill Nygren, a portfolio manager at

Oakmark Funds

, which owns around 4 million shares of J.C. Penney. But Eckerd "can be the third-largest and still be nicely profitable."


The drugstore business is poised for solid growth over the next decade, propelled by a growing number of Americans hitting age 50, say analysts. Americans spend roughly $90 billion annually on prescription drugs, a figure expected to grow to $170 billion by 2007, or an annual compound growth rate of 9%. "These statistics bear out our thesis that drug retailing is as powerful and as well-positioned as any retail segment today," wrote

A.G. Edwards

analyst Jack Russo in a recent report.

While some retail sectors, most notably the apparel retailing industry, opened too many stores amid the recent boom, very little square footage has been added to the nation's drugstores over the last six years, says another analyst who follows the industry. The upshot: There is plenty of growth out there to grab, this analyst says.

And Eckerd, with a solid presence in the fast-growing South -- 575 of its 2,600 stores are in Florida -- is in a good position to capitalize on the nation's expanding elderly population. And the company will spend about $160 million this year to remodel stores in the Northeast.

On the Cheap

While Penney hasn't offered earnings-per-share estimates for Eckerd, it did give an elaborate financial presentation at its March analyst meeting, enough information to make reasonable estimates. According to calculations by Nygren, the Oakmark fund manager, J.C. Penney overall should earn about $5 a share in five years, with $2 of this coming from Eckerd.

Based on J.C. Penney's recent share price of about $21, this equates to a price-to-earnings ratio of about 4, based on this earnings projection, or about 10 times earnings if only Eckerd is included. Both of these are tiny compared to the current multiples in the department store and drugstore industries.

And while five years may seem a long period to project, it offers the most reasonable method of valuing the company, says Nygren. "In a turnaround of this magnitude, you can't look at 2002 or 2003 earnings," he says.

J.C. Penney stock has nearly doubled this year on hopes that Questrom can work the same magic that rescued Federated in the 1990s. And if he can, the stock has probably only just started its run.