Running head: A COMPARISON OF PROFITABILITY AND PERFORMANCE RATIOS BETWEEN CVS CAREMARK AND WALGREENS

A Comparison of Profitability and Performance Ratios between CVS Caremark and Walgreens Matthew Cherry, Brian S. McDaniel, and Patrick Sumara Benedictine University

A COMPARISON OF PROFITABILITY AND PERFORMANCE RATIOS BETWEEN CVS CAREMARK AND WALGREENS 2 Table of Contents Measuring the Companys Profitability .............................................................................. 3 Profit Margin Ratio ......................................................................................................... 3 Return on Assets Ratio.................................................................................................... 3 Return on Equity Ratio ................................................................................................... 4 Discussion ........................................................................................................................... 5 Profit Margin ................................................................................................................... 5 Return on Assets ............................................................................................................. 6 Return on Equity ............................................................................................................. 7 Conclusion .......................................................................................................................... 7 References ........................................................................................................................... 9 Appendix A ....................................................................................................................... 10

A COMPARISON OF PROFITABILITY AND PERFORMANCE RATIOS BETWEEN CVS CAREMARK AND WALGREENS 3 A Comparison of Profitability and Performance Ratios between CVS Caremark and Walgreens Measuring the Companys Profitability This paper examines the three key financial ratios between CVS Caremark and Walgreens for the years ending 2008 to 2012. We present the profit margin, return on assets, and return on equity of CVS, compare those same ratios to results for Walgreens with commentary, and then answer questions relevant to our conclusion about CVS. Profit Margin Ratio Profit margin measures the net income produced by each dollar of sales (Needles, 2012).

Applying this formula to the financial statements of CVS Caremark, we see that profit margin peaked in FY2009 at 18.13%. This is the result of efficiencies gained after the merger of CVS with Caremark in late FY2008. The improved efficiencies do not appear to have generated long-term impact on the company as the profit margin slid during the two following years. Profit increased slightly in FY2012, led by increased prescription reimbursements because of the public dispute between Walgreens and Express Scripts that year.
2008 $ 3,212 Net Income $ 18,290 Net Sales Profit Margin 17.56 %
Table 1: CVS Profit Margin (2008-2012)

2009 $ 3,696 $ 20,380 18.13 %

2010 $ 3,427 $ 20,257 16.92 %

2011 $ 3,461 $ 20,561 16.83 %

2012 $ 3,877 $ 22,506 17.23 %

When compared to the industry average (n=23.99%), we see that CVS has underperformed its peers significantly. Return on Assets Ratio Return on assets measures a companys overall earnings power (Needles, 2012). This ratio gives an idea as to how efficient management is at using its assets to generate earnings.

A COMPARISON OF PROFITABILITY AND PERFORMANCE RATIOS BETWEEN CVS CAREMARK AND WALGREENS 4

Applying this formula to the financial statements of CVS Caremark, we see stable results overall, with both net income and total assets growing at a similar rate. In FY2009, net income peaked at approximately $3.7-billion and generated a higher than average ROA.
2008 $ 3,212 Net Income $ 60,960 Total Assets $ 57,841 Avg. Total Assets Return on Assets 5.55 %
Table 2: CVS Return on Assets (2008-2012)

2009 $ 3,696 $ 61,641 $ 61,301 6.06 %

2010 $ 3,427 $ 62,169 $ 61,905 5.54 %

2011 $ 3,461 $ 64,543 $ 63,356 5.46 %

2012 $ 3,877 $ 65,912 $ 65,228 5.94 %

When compared to the industry average (n=6.8%), we see that CVS has underperformed its peers marginally. However, we see an upward trend of total assets beginning in FY2008. The steady increase of assets appears to be intentional as CVS accelerated acquisitions of other companies as a way to grow their business through market share. CVS acknowledges the temporary inefficiency in their annual report, saying, When the economy reboundswe will have outstanding, well-run assets in place. Return on Equity Ratio Return on equity measures the return to stockholders, or the profitability of stockholders investments (Needles, 2012).

Applying this formula to the financial statements of CVS Caremark, we see consistent results over the five-year period beginning in FY2008. There is a variance in FY2009 as net income rose by 15% year-over-year. The lead cause of the increase was the result of the CVS acquisition of Longs Drug Store, which generated $6.6-billion compared to FY2008.
2008 $ 3,212 2009 $ 3,696 2010 $ 3,427 2011 $ 3,461 2012 $ 3,877

Net Income

A COMPARISON OF PROFITABILITY AND PERFORMANCE RATIOS BETWEEN CVS CAREMARK AND WALGREENS 5
$ 34,574 Stockholders Equity Avg. Stockholders Equity $ 32,948 Return on Equity 9.75 % $ 35,768 $ 35,171 10.51 % $ 37,700 $ 36,734 9.33 % $ 38,051 $ 37,876 9.14 % $ 37,704 $ 37,878 10.24 %

Table 3: CVS Return on Equity (2008-2012)

When compared to the industry average (n=12.17%), we see that CVS has underperformed its peers marginally. This factor is not a significant concern, however, as CVS has the largest market capitalization of its peers. Discussion Having calculated the profitability and performance ratios for CVS, we now turn to Walgreens. We calculated the same ratios (profit margin, return on assets, and return on equity) and then compared them to gain insight into the operation of both companies, CVS in particular.1 Profit Margin During the five-year comparison period, CVS reported higher profit margins. As previously discussed, profit peaked in FY2009 as the result of the merger between CVS and Caremark. On the other hand, Walgreens profit swung sharply between FY2011 and FY2012.
20.00% 18.00% 16.00% 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% 2008 2009 CVS 2010 Walgreens 2011 2012 12.96% 11.13% 11.01% 13.24% 10.45% 17.56% 18.13% 16.91% 16.83%

17.22%

See Appendix A for the Walgreens calculations.

A COMPARISON OF PROFITABILITY AND PERFORMANCE RATIOS BETWEEN CVS CAREMARK AND WALGREENS 6 In FY2011, Walgreens profit margin greatly benefitted from managements decision to restructure debt. The company successfully improved net income by reducing debt payments. In the following year, Walgreens profits plummeted after a major dispute with Express Script, one of the largest pharmacy benefits management companies in the United States. The two companies were unable to agree to payment terms of a new contract. As a result, Walgreens made the strategic decision not to work with Express Scripts, a decision that severely hurt revenue and forced the company to concede later in the year. (Wahba & Krauskopf, 2011) Both companies were below industry average for profit margin in FY2012. Return on Assets The dispute with Express Scripts also greatly impaired Walgreens Return on Assets in FY2012. As you can see from the chart below, Walgreens suffered a significant in performance because net income declined significantly. CVS, on the other hand, saw improved return on assets because of the shift in consumer purchasing during the Walgreens/Express Scripts feud.
12.00% 10.34% 10.00% 8.44% 8.00% 6.00% 4.00% 2.00% 0.00% 2008 2009 CVS 2010 Walgreens 2011 2012 5.53% 6.03% 5.54% 5.46% 8.13% 6.98% 5.94% 10.10%

A COMPARISON OF PROFITABILITY AND PERFORMANCE RATIOS BETWEEN CVS CAREMARK AND WALGREENS 7 Walgreens had a profit margin that was slightly higher than the industry average in FY2012, while CVS was below industry average. Return on Equity The troubles with Express Script could not have come at a worse time for Walgreens. In FY2011, Walgreens tendered an offer to acquire Swiss health and beauty products retailer Alliance Boots for cash and stock. In June 2012, Walgreens paid $6.5-billion in cash for a 45% equity position in Alliance (Felsted, Gelles, & Jopson, 2012). The company recorded a $4billion cash expense as well as an 83.4-million share increase in treasury stock. These two events led to a 22.8% increase in Shareholders Equity in FY2012, significantly reducing stockholder returns that year.
20.00% 18.00% 16.00% 14.00% 12.00% 9.74% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% 2008 2009 CVS 2010 Walgreens 2011 2012 10.50% 9.32% 9.13% 14.72% 14.53% 12.01% 10.24% 17.99% 18.55%

Both companies were below industry average for return on equity in FY2012. Conclusion CVS Caremark considers itself to be an industry-leading PBM business, retail pharmac[y], and retail health [clinic] (CVS Caremark, 2012). It is their goal to provide greater

A COMPARISON OF PROFITABILITY AND PERFORMANCE RATIOS BETWEEN CVS CAREMARK AND WALGREENS 8 access, convenience, and choice to pharmacy care; to deliver solutions that improve the health of their customers; and to lower the overall cost of health care. They utilize their dominate market position, access to cash and credit, and business process to deliver on these goals. Based upon our analysis, we believe that CVS is well-positioned to meet the financial goals stated in the Management Interview. The company maintains a consistent profit margin overall and uses surplus cash to acquire other businesses that management believes will aid longterm growth. When compared to Walgreens, we believe that CVS is the more financial stable organization. There are a variety of prospects for future growth, according to management. The company will place particular focus on Medicare Part D as a revenue source, but also plans to position itself to take advantage of overall health care reform in the United States. We believe that the company can continue at its present growth rate using this strategy.

A COMPARISON OF PROFITABILITY AND PERFORMANCE RATIOS BETWEEN CVS CAREMARK AND WALGREENS 9 References CVS Caremark. (2012, February 25). Annual Reports. Retrieved from CVS Caremark: http://thomson.mobular.net/thomson/7/3280/4593/ Felsted, A., Gelles, D., & Jopson, B. (2012, June 19). Walgreens aims global with Boots tie-up. Retrieved from Financial Times: http://www.ft.com/intl/cms/s/0/69c41626-ba2a-11e1aa8d-00144feabdc0.html#axzz2LydhWk5c Needles, J. B. (2012). Financial Accounting. Mason, OH: South-Western, Cengage Learning. Wahba, P., & Krauskopf, L. (2011, December 30). Walgreen preps customers for loss of Express Scripts. Retrieved from www.Reuters.com: http://www.reuters.com/article/2011/12/30/us-walgreen-idUSTRE7BK0TJ20111230

A COMPARISON OF PROFITABILITY AND PERFORMANCE RATIOS BETWEEN CVS CAREMARK AND WALGREENS 10 Appendix A Financial Ratios for Walgreens
2008 $ 2,157 $ 16,643 Profit Margin 12.96 % 2008 $ 2,157 $ 22,410 N/A 10.34 % 2 2009 $ 2,006 $ 17,613 11.38 % 2009 $ 2,006 $ 25,142 $ 23,776 6.06 % 2009 $ 2,006 $ 14,376 $ 13,623 14.73 % 2010 $ 2,091 $ 18,976 11.01 % 2010 $ 2,091 $ 26,275 $ 25,709 5.54 % 2010 $ 2,091 $ 14,000 $ 14,488 14.53 % 2011 $ 2,714 $ 20,492 13.24 % 2011 $ 2,714 $ 27,454 $ 26,865 5.46 % 2011 $ 2,714 $ 14,847 $ 14,624 18.56 % 2012 $ 2,127 $ 20,342 10.45 % 2012 $ 1,986 $ 33,462 $ 30,458 5.94 % 2012 $ 1,986 $ 18,236 $ 16,542 12.01 %

Net Income Net Sales

Table 4: Walgreens Profit Margin (2008-2012)

Net Income Total Assets Avg. Total Assets Return on Assets

Table 5: Walgreens Return on Assets (2008-2012)

2008 $ 2,157 Net Income $ 12,869 Stockholders Equity Avg. Stockholders Equity N / A Return on Equity 17.99 % 3

Table 6: Walgreens Return on Equity (2008-2012)

2 3

Return on Asset information for FY2008 provided by Morningstar Return on Equity information for FY2008 provided by Morningstar.