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A Prescription for Success at CVS

Analysts want good news on earnings and no bad news on its Eckerd acquisition.

Investors and analysts will be looking for positive words from



on its recently announced acquisition of 1,260


drugstores, as well as signs the company has tightened the gap with its main rival



, when it reports first-quarter earnings Wednesday morning.

Based on already released same-store and total sales data, analysts are expecting another solid quarter from CVS, boosted by a strong Easter. Earnings are expected to rise at least 17% to 56 cents a share, compared to 48 cents a share in the year-earlier quarter.

Wall Street wouldn't be surprised to see results beat the consensus by at least a penny as quarterly earnings have met or exceeded analysts' projections for at least the last two years.

CVS said on April 13 that sales in the 13 weeks -- ended April 3 -- rose 8% to $6.82 billion, while same-store sales were up 6.4%, ahead of its own guidance. By segment, pharmacy same-store sales increased 8.3% and front-end same-store sales rose 2%. In the first quarter of 2003, total same-store sales increased 3.9%, pharmacy same-store sales rose 7.1% and front-end results fell 2.7%.

Though the Eckerd deal won't affect the quarter's results, analysts will expect an update on it during the company's postearnings conference call. Tom Goetzinger, who covers CVS at Morningstar, expects the call's listeners to ask the company to confirm that nothing is standing in the way of the previously proposed June completion.

As a result of the acquisition, though, both Goetzinger and Argus analyst Joe Bonner see Woonsocket, R.I.-based CVS as better-positioned to compete against No. 1 drugstore chain Walgreen. CVS still has a long way to go, however.

On March 22, Walgreen said its profit jumped 17% in its latest quarter, while earnings per share missed analysts' estimates by a penny. Sales rose 16% to a record $9.8 billion and same-store sales were up 11.5%.

In fact, Bonner thinks the main reason CVS is buying the Eckerd chains is so it can more adequately compete with Walgreen. "That was the genesis of the Eckerd deal," he said.

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Goetzinger said the acquisition can help improve CVS' ability to fill more prescriptions, a main source of competition in the drugstore space. "Walgreen tends to produce more volume and more prescription per store per day on average," he said. "By doing that, it has more dollars to spread into store operating costs," which helps it grow its store count quickly and with no debt.

Thus, it could be hard for CVS to penetrate that, even with more stores in its arsenal. "Walgreen is better with customer service and the convenience game with its 24-hour drive-through pharmacies," said Goetzinger. Once CVS' acquisition of Eckerd is complete, the company will have about 5,000 stores, which is about 600 more than Walgreen's current count.

CVS' stock price reflects investor confidence in the company, however. Shares closed up 2.2% Monday at $39.49, and are up about 6% since the $2.15 billion deal with

J.C. Penney



announced on April 5. CVS shares are up about 10% year to date.

In comparison, shares of Walgreen are up 3.5% since early April and down about 2% year to date. Walgreen shares closed up 1.5%, at $35.01, on Monday.

It can be said, Bonner noted, that "Whatever is good for CVS, is bad for Walgreen."

Interestingly, the companies' forward price-to-earnings ratios show that Walgreen is poised for more growth than CVS. Walgreen's forward P/E ratio is 23.64 based on fiscal-year 2005 expected earnings, while CVS' P/E ratio is 15.18 based on fiscal-year 2006 expected earnings.

The discrepancy could be because of the big amount of transition time -- CVS has forecast 18 months to two years -- it will need to rebrand the Eckerd stores, which have been plagued with inventory issues and low customer traffic. But J.P. Morgan analyst Stephen Chick thinks "the equity market will begin to assign CVS a higher valuation multiple as investors become more comfortable with the prospects of the proposed deal." (J.P. Morgan does investment banking for CVS.)

Meanwhile, competition in the drugstore industry is coming from all sides. Apart from individual chain-drug rivalries, the industry has faced increased pharmacy competition from discount retail chains. Pharmacies at






, for example, have lured traffic away in part because they are convenient one-stop shops, where busy consumers can also buy groceries, apparel and home electronics from the same location.

Drugstore gross margins have also lately been hurting because the stores tend to sell more low-margin pharmacy products than high-margin front-end products, as prescriptions often comprise more than half of a drugstore's total sales. Further, Walgreen noted in its latest quarter that fewer new generic prescription products were introduced in the last year, which hurt gross margin; generic drugs tend to have better gross margin rates than branded drugs.

But pharmacies could be in luck this summer when more name brand drugs hit shelves in generic form. Argus Research pharmaceutical analyst John Watkins said several blockbuster drugs will be available in generic form starting in June, including the antibiotic Biaxin, manufactured by

Abbott Labs


, and the antibacterial Cipro, made by

Barr Labs