From the December 2011 issue of Research Magazine • Subscribe!

Above-Peer Performance

Modest economic growth and stable margins bode well for consumer-oriented companies.

Steven P. Halper
Stifel Nicolaus
212-271-3807
shalper@stifel.com
Before the market open on November 3, CVS Caremark reported solid 3Q’11 results. During 3Q’11, retail same-store sales were 2.3 percent, and the company appears to be tracking nicely to its full year guidance of 1.5-2.5 percent. Notably, front-store comparable sales increased 2.0 percent, which is the strongest performance in two years.

The company did not sacrifice margin to drive same-store sales. However, the company expects increased promotional activities in 4Q’11. We are not concerned about this given the strong retail performance over the first nine months of the year. Pharmacy benefit management (PBM) performance continues to improve and the company reiterated its view that it expects “healthy” growth in PBM profitability in 2012.

The company will provide more specifics regarding its 2012 outlook at its investor day in late December, which is likely to be the next near-term catalyst for the stock. Our 2011 and 2012 adjusted EPS estimates remain unchanged at $2.80 and $3.23, respectively, but both estimates are already above consensus.

The company raised the low end of its 2011 EPS guidance range to reflect the quarter as well the accretion related to the divestiture of its TheraCom unit. We have increased our target price from $42 to $44, mainly to reflect the change from year-end 2011 to year-end 2012. Given the likelihood of strong free cash flow over the next five years and beyond, we remain buyers of the shares.

As reported, consolidated revenue in the quarter increased 12.5 percent year over year. Retail-segment revenue (before eliminations) grew 3.8 percent and PBM revenue grew 26 percent. Retail growth was driven primarily by 2.3 percent in comparable-store sales. Front store sales grew 2.0 percent while pharmacy comparable sales increased 2.4 percent. Generics negatively impacted sales growth by 200 basis points while maintenance choice increased sales by 140 basis points.

Looking ahead, the company expects 4Q’11 same stores growth of 0.5-2.5 percent (we are forecasting 2 percent) and lower gross profit margin due primarily to increased promotional activities. Operating profit should still grow 4-7 percent in 4Q’11. We are not concerned about the decline in gross margins in 4Q’11 given the strong year-to-date performance.

Looking ahead to 2012, we assume same-store sales of 3.6 percent and just 6.0 percent growth in operating profit. Our operating profit growth assumption is probably conservative.

PBM network revenue grew 24 percent year over year, driven primarily by the Aetna contract. Mail choice revenue grew 16 percent (another sequential increase).

Eric Serotta, CFA
Wells Fargo Securities
212-214-8035
eric.serotta@wellsfargo.com
We are reiterating our Outperform rating on shares of Kraft Foods following solid Q3’11 results characterized by strong organic top-line growth and effective cost management. We continue to believe the planned split-up of the company will unlock value for shareholders given the above-peer growth profile of the global snacks company, the operational improvement opportunities available to each company, and the ability of each company to pursue different capital allocation priorities.

Kraft reported Q3’11 adjusted EPS of $0.58, $0.03 above consensus and in line with our estimate. While adjusted EPS benefited by approximately $0.04 from a favorable tax rate, operating results were nevertheless strong. Sales increased 8.4 percent on an organic basis, driven by 7.0 percent pricing and 1.4 percent volume/mix benefit.

Christopher Growe
Stifel Nicolaus
314-342-8494
growec@stifel.com
Kraft Foods reported its 3Q’11 EPS was up 23 percent to $0.58, which was $0.04 ahead of our estimate and $0.03 ahead of the consensus estimate, although the majority of this earnings “beat” flows from a lower tax rate in the quarter.

This quarter’s performance was another solid one, in our view: Organic revenue growth of +8.4 percent and organic operating profit growth of +12 percent led to the strong EPS growth conclusion in the quarter.

EPS was about in line with our expectation excluding the tax benefit, but with such strong revenue growth, including volumes. We see this quarter as one that should lift the stock price from this level and provide high confidence in the upcoming fourth quarter. In addition, the company raised its 2011 revenue growth guidance again (to at least +6 percent growth) and its EPS growth guidance (to at least $2.27, up $0.02).

We are raising our estimate for the year by $0.01 to $2.28 and estimating just over 6 percent growth in revenue on an underlying, organic basis.

Once again, Kraft’s revenue growth stands atop the food industry and is especially impressive considering the heavy price realization across its business. Frankly, we are not seeing volume growth at many companies in the food industry these days and Kraft’s 1.4 percent volume growth really stands out for us in this quarter.

We remain encouraged by the outlook for the business particularly in light of the strong top-line growth performance.

Eric Beder
Brean Murray, Carret & Co.
212-702-6619
bedere@bmur.com
1-800-Flowers’ (FLWS) shifted focus back to traditional, yet one-of-a-kind product designs, especially in the consumer-floral segment, [which] has resulted in top-line expansion. Consumers have responded positively towards the A-dog-able and Happy Hour collections, and that is just the beginning as the company is slowly rolling out edible floral arrangements online, and will go nationwide with the initiative once enough florists are certified to offer the line.

We believe as a result of the variety of quality product offerings, that 1-800-Flowers will be a one-stop-shop for all occasions and continue to take market share from weaker competition; further, the shift to unique items has allowed the company to drive higher margins than players focused on commodity driven items.

The integration of the 1-800-Flowers and 1-800-Baskets websites has proven its effectiveness in driving increased levels of traffic and spreading brand awareness; in effect, the core 1-800-Flowers shopper is now exposed to the 1-800-Baskets line on a much more conscious level. On Friday, September 2, the company introduced both Cheryl’s and Fannie May tabs to 1800flowers.com, now giving consumers the ability to add product from all four brands (1-800-Flowers, 1-800-Baskets, Cheryl’s and Fannie May) to one basket and proceed to checkout at one destination.

By leveraging the 1-800-Flowers brand, the company is now offering a complete flower/gift shop concept which, in our view, can satisfy a wider variety of consumers’ gifting needs. The company expects to have the website fully integrated within the next two years. We believe by enhancing the overall online experience and making the other brands available with just a click of the mouse, the company will be able to easily spread brand awareness and increase top-line results; while early, initial results have been encouraging.

Over the last 16 years, the number of florists has declined by approximately 50 percent (to about 16,000 locations). Management believes the worst is over for the segment, and that the remaining florists are stronger economically.

The company has aggressively added services to the Bloomnet network to offer more value added to their florists, including floral, chocolate, plush, gift and exclusive Yankee Candle programs; they have also created educational and training programs which have fostered a sense of community in the florist network that was once the hallmark of FTD (when it was a non-profit, florist-owned business).

1-800-FLOWERS.com has also begun to slowly add florists to the franchising mix. The co-branded stores have shown excellent results and have materially raised the profile of the company; management is focused on only accepting the “best of the breed” as franchisees.

During fiscal year 2012, the company plans to pay down approximately $16 million in debt, bringing the remaining debt balance to $30 million as they remain focused on strengthening the balance sheet and lowering the debt/equity ratio. In addition, if the $12 million received for the WTN Services is not reinvested within the next 12 months, by contract, this money will be allocated to pay down additional debt.

The company has not anticipated any improvement in consumer-spending habits in their guidance. That said, despite hard macroeconomic times, management is confident they will continue to grow the top and bottom line going forward. We believe if the consumer does increase spending, results will surpass expectations.n

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