Jon R. Andersen
William Blair & Company
Alberto-Culver’s (ACV) portfolio of leading personal care brands (No. 4 in U.S. hair care), brand-building talent (five-year compound annual sales growth of 8 percent), and track record of value-enhancing acquisitions position it as one of the better long-term growth opportunities among mid-cap stocks in consumer products, in our view.
We believe the company can improve margins at an average rate of 80 basis points per year, driven by favorable product mix and restructuring-related cost savings.
We project long-term annual revenue growth of 6 percent to 7 percent and EPS growth of 13 percent.
We believe upside is possible in the near term, given contributions from new products and restructuring, and for the longer term, as a conservative balance sheet and scalable infrastructure provide for accretive acquisitions and share repurchases.
Our Alphawise PBM (pharmacy benefit management) consultant survey suggests that CVS Caremark’s (CVS) PBM business is stabilizing, with 47 percent of consultants indicating the company could gain share in the current 2011 selling season versus 19 percent expecting a share loss.
We continue to see valuation expansion potential in CVS shares as PBM prospects improve. Applying a drugstore valuation of 7.5 times EV (enterprise value)/EBITDA to the CVS retail operations, we estimate that the PBM is trading at 8.0 times EV/EBITDA, an approximate 30-40 percent discount to the PBM competitors Medco and Express Scripts (at 10.7 times and 12.0 times respectively).
Based on recent state filings, it appears that CVS Caremark may have taken a $1 billion PBM contract from Express Scripts (ESRX) for a midyear 2010 renewal in the State of Massachusetts.
The state’s Group Insurance Commission (GIC) voted recently to contract with CVS Caremark, thereby replacing Express Scripts, who held the contract for 8 years. The fact that CVS “is a local company with a large network of retail pharmacies” was cited as at least part of the reason for the switch.
The new contract with CVS will commence July 1, 2010, and will run for 3 years. Massachusetts GIC estimates the contract value at $1 billion.
Given that this contract likely generates annual gross revenues in the $300-350 million range, and if we further assume that mail penetration rates and margins are in line with current corporate averages, this contract is likely worth only $0.01 in incremental annual EPS for CVS.
We believe this contract is a major positive for investor sentiment (even though we estimate it only adds a penny to EPS); we are leaving our 2010 and 2011 EPS estimates of $2.84 and $3.20 unchanged.
We maintain our Buy rating on CVS as we believe the contract win and positive comments regarding the selling season made by management at a recent conference may improve sentiment. Our $40 price target assumes shares trade at 14 times our 2010 EPS estimate of $2.84.