The initial intent of this analysis was to identify changes in accounting methods within the financial statements of Walgreens and CVS Caremark, as well as to compare and contrast their financial statements, in order to draw conclusions about which company had also have better earnings. However, in the process of this analysis, with the exception of a minor change to lease accounting by Walgreens, there were no major changes in accounting methods identified.
In examining the financial statements for these two drugstore industry leaders, the analysis shows that while each company conducts retail drugstore operations in similar ways, their business models for carrying out these operations greatly vary. These variances in business model led the analysis to focus on earnings from operations, operations costs, balance sheet analysis, cash flow analysis, inventory accounting, debt financing and market analysis.
Of the differences that were explored, it was their level of conservatism that most separated these two companies. Walgreens chooses a more conservative approach to their operations by growing organically, while CVS Caremark assumes a riskier business model by growing through acquisitions. This fundamental difference in the two organizations cascades throughout their financial statements in the form of debt for CVS Caremark which is offset by growth of margins and profits; and in the form of a much healthier balance sheet for Walgreens.
This analysis shows the results of each company’s operations, the ramification of those operations on their financial statements, and the conclusion that because of their more conservative, less risky business model, Walgreens maintains a healthier operation, despite equally impressive growth by both companies. Ultimately, the value of each company is left for the investors to determine.
The data, however, shows that CVS Caremark is trying to win the earnings race for drugstore / retail operations and takes advantage of contract dispute between Walgreens and UPMC Health Plan's pharmacy. Walgreens statistics shows best investment opportunity for long term period while CVS Caremark may be fruitful for short term basis. Operations Analysis On a comparable revenue basis during fiscal 2011, CVS Caremark generated net revenues of $107. 100 billion, compared to Walgreen net revenues of $72. 84 billion.
Although CVS Caremark CAGR (compound annual growth rate) over the past 4 years was 6. 98%, slightly higher than Walgreens 6. 93%, the increase was primarily driven by the same store sales, the inclusion of the Longs Acquisition, as well as net revenue from new stores and a positive impact related to the growth of our Maintenance Choice program. Walgreens has expanded organically via new store openings, while CVS has undertaken a strategy of acquiring competitors.
From an earnings perspective, not only are they a larger company by revenues, but Walgreens is also run more efficiently, leading to higher profitability. This is evidenced by a net income margin (Net Income / Sales) of 3. 76% during 2011, compared to CVS Caremark net income margin of 3. 23% during 2011, indicating that for every $1 of sales, Walgreens earns $0. 0376 while CVS only earns $0. 0323 per dollar of sales. Following table shows the movement in net income and margin between both companies over time. Net income is the resulting capital after expenses are paid.
The significance of these table and chart is to expose an increase and decrease in net income of CVS Caremark and Walgreens over the same period, Walgreens net income increased in fiscal year 2011 by $0. 623billion than fiscal year 2010, while CVS Caremark net income increased by $0. 032billion. Although Walgreens net income margin is higher than CVS Caremark in fiscal year 2011 both companies are struggling to maintain consistency in net income from its operations. Additionally, it shows both companies ability to keep their capital growing with time.
As a result, CVS Caremark reported an earnings before income, taxes, depreciation and amortization margin (EBITDA/Sales) of 7. 37% of net revenues in 2011, which was slightly higher than Walgreens7. 11%. Although CVS Caremark EBITDA only higher by 0. 26% these EBITDA margins are comparable. Walgreens differentiates itself with a net income margin of 3. 76% vs. CVS Caremark 3. 23%.
The difference was primarily due to interest cost and depreciation & amortization expenses. Walgreens interest cost and depreciation & amortization was $0. 71 billion and $1. 028 billion as compared to CVS Caremark which was $0. 584 and 1. 568 billion. This reflects an increase in Walgreens net income. Revenues From 2008 to 2011, CVS Caremark reported a compounded annual growth rate of 6. 98%, growing to $19. 628 billion in total revenues. The increase was primarily driven by the same store sales, the inclusion of the Longs Acquisition, as well as net revenue from new stores and a positive impact related to the growth of our Maintenance Choice program.
As of December 2011 CVS Caremark stores were 7,327 as new retail stores opened 247and closed stores were 102in fiscal year 2011. During 2010, CVS Caremark operated 7,182 retail stores, compared to 7,025 retail stores on December 31, 2009, and 6,923 retail stores on December 31, 2008. Total net revenues from new stores (excluding acquired stores) contributed approximately 1. 58%, 1. 4%, 1. 6% and 1. 5% to total net revenue percentage increase in 2010, 2009 and 2008, respectively.
Sales from retail pharmacy and pharmacy services segment almost 50% of total revenue year over year basis. From 2008 to 2011, Walgreens reported a compounded annual growth rate of 6. 93%, growing to $13. 150 billion in total revenues. Net sales increased by 7. 1% to $72. 2 billion in fiscal 2011 compared to increases of 6. 4% in 2010 and 7. 3% in 2009. The acquisition of Duane Reade increased total sales by 1. 7% in the current fiscal year compared to an increase of 1. 1% last year.
Drugstore sales increases resulted from sales gains in existing stores and dditional sales from new stores, each of which include an indeterminate amount of market-driven price changes. Sales in comparable drugstores were up 3. 3% in 2011, 1. 6% in 2010 and 2. 0% in 2009. Comparable drugstores are defined as those that have been open for at least twelve consecutive months without closure for seven or more consecutive days and without a major remodel or a natural disaster in the past twelve months. Prescription sales increased 6. 3% in 2011, 6. 3% in 2010 and 7. 8% in 2009.
The acquisition of Duane Reade increased prescription sales by 1. 2% in the current fiscal year versus an increase of 0. 8% last year. Comparable drugstore prescription sales were up 3. 3% in 2011 compared to increases of 2. 3% in 2010 and 3. 5% in 2009. Prescription sales as a percent of total net sales were 64. 7% in 2011, 65. 2% in 2010 and 65. 3% in 2009. The effect of generic drugs, which have a lower retail price, replacing brand name drugs reduced prescription sales by 2. 4% for 2011, 2. 2% for 2010 and 3. 0% for 2009, while the effect on total sales was 1. % for 2011, 1. 3% for 2010 and 1. 9% for 2009.
Third party sales, where reimbursement is received from managed care organizations, the government, employers or private insurers, were 95. 6% of prescription sales in 2011, 95. 3% in 2010 and 95. 4% in 2009. We receive market-driven reimbursements from third party payers, a number of which typically reset in January. The total number of prescriptions filled (including immunizations) was approximately 718 million in 2011, 695 million in 2010 and 651 million in 2009.
Prescriptions adjusted to 30-day equivalents were 819 million in 2011, 778 million in 2010 and 723 million in 2009. Front-end sales increased 8. 5% in 2011, 6. 8% in 2010 and 6. 3% in 2009. The acquisition of Duane Reade increased front-end sales by 2. 8% in the current year versus an increase of 1. 9% last year. Additionally, the increase over the prior year is due, in part, to new store openings and improved sales related to non-prescription drugs, convenience and fresh foods and personal care products. Front-end sales were 35. 3% of total sales in fiscal 2011, 34. % of total sales in fiscal 2010 and 34. 7% in fiscal 2009.
Comparable drugstore front-end sales increased 3. 3% in 2011 compared to an increase of 0. 5% and decrease of 0. 5% in fiscal years 2010 and 2009, respectively. The increase in fiscal 2011 comparable front-end sales was primarily due to non-prescription drugs, beer and wine and convenience and fresh foods, which were partially offset by decreased sales in household products. Walgreens retail stores were 8,210, 8,046, 7,496 and 6,934 in 2011, 2010, 2009 and 2008 respectively.
Performance review of CVS Caremark typically shows fluctuation in gross margin (gross profit / revenue), the trend was 21. 01%, 20. 64%, 20. 90% and 20. 91% in fiscal year 2011, 2010, 2009 and 2008 respectively. During 2011 gross profit increased by 0. 37%, the increase in retail pharmacy segment as report issued by http://www. morningstar. com on quarter 4 of 2011.
During 2010, in retail pharmacy segment increased by 2. 7% offset by declines in Pharmacy Services segment of 12. 6%. During 2009, the Longs Acquisition increased gross profit dollars by $1. billion, but negatively impacted company’s gross profit rate compared to 2008. The results for 2008 include gross profit from the Longs Drug Stores and RxAmerica from the acquisition date (October 20, 2008) forward. A change in Centers for Medicare and Medicaid Services (CMS) regulations, the termination of a few large client contracts effective January 1, 2010 and the decrease of covered lives under our Medicare Part D program, partially offset by new client starts on January 1, 2010.
The decrease in gross profit as a percentage of net revenues is primarily due to the loss of “differential” or “spread”, pricing compression related to a large client renewal that took effect during the third quarter of 2010, and the change in the revenue recognition method from net to gross associated with the RxAmerica pharmacy network contracts on April 1, 2009 and a large health plan on March 1, 2009. This was partially offset by an increase in our generic dispensing rate for the year ended December 31, 2010, as compared to the prior year. Walgreens gross margin was 28. 38% in 2011, 28. 16% in 2010, 27. 80% in 2009 and 28. 19% in 2008.
Overall gross margins since 2009 were positively impacted by higher front-end margins due to pricing, promotion and other improved efficiencies and lower Rewiring for Growth costs. Retail pharmacy margins benefited from the positive impact of generic drug introductions but were partially offset by market-driven reimbursement rates. During 2009, gross margin was negatively impacted by non-retail businesses, including specialty pharmacy, which have lower margin and are becoming a greater part of the total business, lower front-end margins due to product mix, a higher provision for LIFO and restructuring and restructuring related costs.
For both retailers, as pharmacy sales continue to grow at a faster rate. Walgreens gross profit is increasing since 2009 while CVS Caremark gross profit was slightly lower in 2010 as compared to previous years this was due to change in revenue recognition method of a segment and price differential. During 2011 both companies demonstrate significant gross profit margin and shows capability to achieve high margin. Operating Expenses Operating expenses include, but are not limited to; expenses associated with running a business but are not considered directly applicable to the current line of goods and services being sold.
Examples include sales and marketing, general and administrative, operating leases, and employee benefits. The following represents highlights of the major operating expenses between the two companies and their impact on earnings. CVS Caremark reported operating expenses $14. 231 billion, $14. 092 billion, $13. 942 billion and $12. 244 billion in 2011, 2010, 2009 and 2008 respectively. The ratio of operating expenses to sales was 13. 29% in 2011, 14. 62% in 2010, 14. 12% in 2009 and 14. 00% in 2008. CVS successfully cut its operating costs in 2011 while employees cost increased year over year basis.
During 2009 & 2010 operating cost was higher than 2008 due to legal services associated with increased litigation activity, information technology services associated with enterprise initiatives, compensation and benefit costs, and depreciation. Further, expenses incurred on dissolution of joint venture. Despite having higher gross margins than CVS, Walgreens has historically reported higher operating expenses (selling, general and administrative expenses) as percentage of sales than CVS, meaning that on a comparable basis, for each $1 of sales, Walgreens has operating expenses of $0. 23 and CVS has operating expenses of $0. 13.
Walgreens lease rent was $0. 15 as compared to CVS lease rent $0. 14 for each $1 of operating expenses. Depreciation of property and equipment includes in operating expenses. CVS Caremark reported depreciation expenses in 2011 $1. 6 billion as compared to Walgreens depreciation which was $1. 0 billion. Despite higher net earnings of Walgreens in 2011 as compared to CVS Caremark, operating expenses of Walgreens needs a reduction.
Interest Expenses CVS Caremark reported $584 million interest during 2011 as compared to Walgreens $71 million. CVS Caremark acquires the Medicare Part D business of UAC for approximately $1. 25 billion, the acquisition transaction will close by the end of the second quarter of 2011. Due to historical acquisition activity of CVS Caremark increases its debt ultimately an increase in interest expenses.
Assuming interest rates continue to rise; this differentiating factor between Walgreens and CVS will continue to grow, as Walgreens will earn a proportionally higher return on investments due to low debt burden while CVS is required to refinance its maturing senior notes at higher interest rates. The impact of this debt burden puts CVS in a very risky position if a major impact to the retail industry is encountered in the marketplace. Balance Sheet Analysis Liquidity perspective, current ratio consists of total current assets / total urrent liabilities.
The meaning of current assets and current liabilities is possession of resources to pay short term obligations within one year. Both companies are considered fairly liquid with a current ratio of 1. 52 for Walgreens and 1. 56 for CVS Caremark at fiscal year 2011. This is an indication that both companies have managed their liquidity and strengthened their ability to pay short-term debts with current assets. Despite CVS Caremark heavy long-term debt obligations, they are well-suited to manage short-term financial commitments.