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Top Picks 2012: CVS Caremark

 December 28, 2011 12:22 PM

by Jim Stack, editor InvesTech Market Analyst

CVS Caremark (CVS) was created in 2007 by the merger of two pharmacy heavyweights:  CVS, the nation's second largest drugstore chain and Caremark, a leading Pharmacy Benefits Manager (PBM).  

The company's combined operations – which include the nearly 7,400 CVS retail locations and Caremark's claims processing and mail-order business – allow it to process more than 1 billion prescriptions annually and make it the largest pharmacy company in the country.

CVS's strong market presence is well suited for an aging U.S. population that will almost certainly demand more prescriptions. Over the next 20 years the U.S. population "65 and older" is expected to grow from 40 million to 72 million – a 79% total increase. 

By 2030, 19% of the U.S. population will be over 65, compared with 13% currently. This is a key growth demographic for CVS as people 65 and older fill an average of 25 prescriptions annually – nearly three times the national average.

As the largest purchaser of drugs in the U.S., CVS is well positioned to meet this growing prescription demand. In particular, CVS's bargaining power with generic drug manufacturers is a key advantage.  

Generic drugs often generate gross profits that are 40% higher than profits earned on branded counterparts.  As 2011 comes to an end and we head into 2012, CVS should benefit from the largest slate of major generic launches (Lipitor, Plavix, Singulair, etc.) in years.  

The fundamental outlook is so strong that CVS management is guiding to double-digit earnings growth for the next 5 years. 

Company executives expect revenue to grow at 8 to 11% per year, while earnings per share are expected to increase at 10 to 15% per year.  

Much of this growth will likely be returned to shareholders through dividends and stock buybacks. CVS has been increasing its dividend, which currently yields 1.3%, at 22% per year for the last 5 years, and is on track to top $1 billion in share buybacks this year alone.

Today CVS shares are trading at just 13.7x earnings, a steep discount to its 10-year median valuation of 18.1x earnings.  

With positive industry trends, projected double-digit earnings growth and a 30% discount to historic valuation levels, CVS is a solid company with great appreciation potential.
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