U.S. Markets open in 2 hrs 45 mins

Pharmacies and Drug Stores Stock Outlook: Prospects Bright

Zacks Equity Research
1 / 2
Pharmacies and Drug Stores Stock Outlook: Prospects Bright

Over the past few years, an aging population, increasing wealth among the middle class, government focus on healthcare infrastructure and growing healthcare awareness have been driving the global retail pharmacy and drugstore industry. In North America, this industry has taken the shape of a multi-laired business, selling not just a range of prescription and over-the-counter medications but items such as wellness products and groceries.

Going by Statista data, by 2020, sales of retail pharmacies and drug stores in the United States are projected to reach approximately $251.14 billion. Undoubtedly, its enormously attractive market potential has made this space a happy hunting ground for global healthcare players.

However, with E-commerce giant Amazon’s (AMZN) big move to foray into the healthcare space along with other non-healthcare mammoths like Berkshire Hathaway Inc. (BRK.B) and JP Morgan (JPM), the traditional retail pharmacy and drugstore industry is about to witness a sea change. According to most market watchers, the entry of these heavyweights has the potential to unsettle traditional healthcare system in the United States.

Going by an article published in Wolters Kluwer, with this, the retail pharmacy industry has entered a new period of fierce competition that is forcing pharmacies to further reduce their prescription profit margins.

Nevertheless, the existing players in the drugstore industry do not seem to be in a mood to give up and lose their turf. To counter competition, the companies operating in the space are strategically attempting to gain in size and scale — both organically and inorganically.

Some of the notable deals include the acquisition of Aetna Inc. (AET) by CVS Health and Express Scripts by Cigna; purchase of the primary care unit of DaVita by UnitedHealth Group Inc.; Rite Aid’s merger with Albertson's and Walgreens Boots Alliance partnership with Humana to set up primary care clinics. All these companies are gradually getting ready to face the radical changes.

Industry Underperforming S&P 500 & Sector

While the industry leaders are making an all-out effort to hold their ground when the winds of change blow, judging by shareholder returns over the past year, it seems that, investors aren’t quite upbeat about the industry as a whole at the moment.

Going by a recent PWC article, it seems that investors are worried about the gradually shrinking margins in the core retail pharmacy business and tougher competition in a shifting health industry.

This reflects in the underperformance of the Zacks Retail - Pharmacies and Drug Stores industry, which is a 6-stock group within the broader Zacks Retail and Wholesale, with respect to both the S&P 500 and its sector over the past year.

While stocks in this industry have collectively declined 9.7%, the Zacks S&P 500 Composite and Zacks Medical Sector have rallied a respective 16.7% and 8.5%.

One-Year Price Performance

 

Retail - Pharmacies and Drug Stores Stocks Trading Cheap

Given the industry’s underperformance so far this year, the valuation looks cheap now. Valuation is a tricky business for the Retail - Pharmacies and Drug Stores companies. Not to forget, of late, these companies have been outlaying a portion of their funds for consolidation and expansion. The spending is significantly high even as the quest for new sources of revenues continues.

However, one might gain a fair idea of the industry’s relative valuation from its Price/Book ratio.

The industry currently has a Price/Book TTM ratio of 2.20, which is toward the high end of the past year. When compared with the high of 2.55X and median level of 2.15X over the past year, we believe investors should wait for a dip to enter the market.

The space also looks inexpensive when compared to the Retail and Wholesale market at large, as the current Price/Book TTM ratio for the broader market is 3.29 and the median Price/Book TTM ratio is 3.10.

Price-to-Book Trailing Twelve Months (TTM)

 

Compared to the Zacks S&P 500 Composite, the space looks inexpensive. The current ratio for the S&P 500 is 3.99 and the median level is 3.79. So, both the figures are above the Retail - Pharmacies and Drug Stores industry’s respective ratio.

Price-to-Book Trailing Twelve Months (TTM)

 

Price Under Pressure Due to Bleak Earnings View

In the recent past, the industry has been affected by the complex regulatory environment and growing external competition.

Historically, the bigger retail pharmacy and drug store companies maintained their competitive position riding on economies of scale in purchasing and access to a large customer base. According to a report by First Research, smaller companies on the other hand, tend to compete effectively through convenient locations or special merchandising. However, access to medical insurance groups was a vital factor for both types of players to earn profits.

However, of late, a poor reimbursement environment and growing industry consolidation have been forcing retail pharmacy companies to spend hugely on research and development seeking for new sources of revenues. In the process of doing so, these companies are currently witnessing increasing pressure on the bottom line.

While the above ratio analysis shows that there is a solid value-oriented path ahead, one should not really consider the current price levels as good entry points unless there are convincing reasons to predict a rebound in the near term.

One reliable metric that can give investors an idea of the industry’s future price performance is its earnings outlook. Empirical research shows that the earnings outlook for the industry, showing the earnings revision trend for the constituent companies, has a direct bearing on its stock market performance.

The Price & Consensus chart for the industry shows the market's evolving bottom-up earnings expectations for it and the industry's aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018.

Looking at the aggregate earnings estimate revisions, it appears that over the past three months, there has been a marginal improvement in this group’s earnings outlook in 2018.

Price and Consensus: Zacks Retail - Pharmacies and Drug Stores

 

One could get a good sense of a company’s earnings outlook by comparing the consensus earnings expectation for the current financial year with the last year’s reported number. This becomes even clearer by focusing on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.

Current Fiscal Year EPS Estimate Revisions

As you can see here, the $4.06 EPS estimate for 2018 is marginally up from $4.04 at the end of May. However, earnings estimates have risen sharply since last year’s $3.81.

Zacks Industry Rank Indicates Prospects for Improvement

The group’s Zacks Industry Rank is basically the average of the Zacks Rank of all the member stocks.

The Zacks Retail - Pharmacies and Drug Stores industry currently carries a Zacks Industry Rank #118, which places it at the top 46% of more than 250 Zacks industries. Our research shows that the top 18% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

On top of that, our proprietary Heat Map shows that the industry’s rank has been in the top 50% for the past the past eight weeks indicating solid near-term prospects.

 

Retail - Pharmacies and Drug Stores Promises Long-Term Growth

The long-term prospects for the industry indicate steady growth as well. When compared with the broader Zacks S&P 500 composite, the long-term (3-5 years) EPS growth estimate for the Zacks Retail - Pharmacies and Drug Stores industry of 10.4% appears promising, at the highest point of the trend at this moment. The corresponding figure for the Zacks S&P 500 composite is 9.8%.

Mean Estimate of Long-Term EPS Growth Rate

 

In fact, the basis of this long-terms EPS growth could be a sharp improvement in the top line that these Retail - Pharmacies and Drug Stores have been witnessing since the beginning of 2015.

Revenues: Zacks Retail - Pharmacies and Drug Stores industry

 

Bottom Line

In an era when brick and mortar setups are being challenged by online sellers, Amazon’s entry into the prescription drug industry has compounded challenges for the existing players. The purchase of online pharmacy delivery company PillPack is expected to provide Amazon instant access to the U.S. drug business worth nearly $370 billion.

Amazon’s entry into drug distribution will definitely be a game changer but the immediate implications will be limited, given that the healthcare space is highly complex and regulated.

Further, as stated earlier, investors should not lose hope as the consolidations between the existing healthcare players are expected to prove equally strategic and crucial for maintaining the competitive edge. Not only inorganic consolidations, players like CVS Health, Walgreens Boots and others have already started to add more digital and customer-friendly programs to their business. These companies have incorporated mail order pharmacy models to their stores with same day/one day to two days delivery programs.

Keeping the long-term expectations in mind, investors could take advantage of the cheap valuation and bet on a few Retail - Pharmacies and Drug Stores stocks that have a strong earnings outlook.

Stock to Buy

Here we have picked one stock from the Retail - Pharmacies and Drug Stores industry, which carries a Zacks Rank 2 (Buy) and has seen positive earnings estimate revision.

Herbalife Nutrition Ltd. (HLF): Based in Los Angeles, CA, Herbalife develops and sells nutrition solutions to consumers interested in weight management and general wellness. It also caters to customers looking for ways to enhance sports and fitness performance. Herbalife has been gaining from its focus on direct selling, which it believes ideally suits its business.

The Zacks Consensus Estimate for current-year earnings moved up 14.2% in the last 30 days. The stock has returned 65% in a year’s time.

Price and Consensus: HLF

 

Stocks to Hold

Investors may also hold on to these couple of stocks that have been seeing positive earnings estimate revision and hold strong long-term growth potential.

CVS Health Corporation (CVS): Headquartered in Woonsocket, RI, CVS Health Corporation is a pharmacy innovation company with integrated offerings across the entire spectrum of pharmacy care. The Zacks Consensus Estimate for current-year earnings moved up 0.6% in the last 30 days. CVS Health, a Zacks Rank #3 (Hold) stock, has returned 2% year to date.

Price and Consensus: CVS

 

Walgreens Boots Alliance, Inc. (WBA): Founded in December 2014, Walgreens Boots Alliance is the world’s first pharmacy-led, health and wellbeing enterprise. The company includes the largest global pharmaceutical wholesaler and distribution network. In addition, Walgreens Boots Alliance is the world's largest purchaser of prescription drugs and several other health and wellbeing products.

The Zacks Consensus Estimate for current-year earnings moved up 0.3% in the last 30 days. Walgreens Boots, also a Zacks Rank #3 stock, has returned 44.1% over the past five years.

Price and Consensus: WBA

 

The Hottest Tech Mega-Trend of All

Last year, it generated $8 billion in global revenues. By 2020, it's predicted to blast through the roof to $47 billion. Famed investor Mark Cuban says it will produce "the world's first trillionaires," but that should still leave plenty of money for regular investors who make the right trades early.

See Zacks' 3 Best Stocks to Play This Trend >>


Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report
 
Walgreens Boots Alliance, Inc. (WBA) : Free Stock Analysis Report
 
JPMorgan Chase & Co. (JPM) : Free Stock Analysis Report
 
Herbalife LTD. (HLF) : Free Stock Analysis Report
 
CVS Health Corporation (CVS) : Free Stock Analysis Report
 
Berkshire Hathaway Inc. (BRK.B) : Free Stock Analysis Report
 
Amazon.com, Inc. (AMZN) : Free Stock Analysis Report
 
Aetna Inc. (AET) : Free Stock Analysis Report
 
To read this article on Zacks.com click here.
 
Zacks Investment Research