CVS Stocks More Food Which Could Add Some More Beef to Our Upside

If we told you that the largest pharmacies chains in the U.S., CVS Caremark (NYSE:CVS) and Walgreens (NYSE:WAG), planned to sell more groceries and produce, would you believe us? If so, you would be right. CVS Caremark plans to double the size of its food section and revamp about 20% of its 7,000 stores to better cater to groceries and quick check outs, ^[1] and Walgreens started to satiate its appetite for the nation’s trillion-dollar food budget by announcing last year that it would add up to 500 food items including salads, sandwiches, frozen meats, soups, juices, yogurts and even sushi to its offering. ^[2]

How do Consumers Benefit?

Drugstores selling groceries offer the consumers convenience. Consumers’ looking for a quick trip and who do not want to drive to the grocery store that might be further away will visit a CVS or Walgreens instead. The refurbished CVS stores have larger grocery sections and self-checkout kiosks for quicker trips. Also, since around 75% of the population lives within a three-mile radius of a CVS store, which is better than for any other drug retail chain (which is five-mile radius for a Walgreens store), CVS stores’ accessibility to a larger consumer base is a huge advantage.

Drugstores are increasingly offering merchandise that people need on an everyday basis and customizing their offerings like carrying sandwiches and quick lunches in stores near office buildings. While drugstores may be convenient, they still cannot boast of ‘best prices’ or replace supermarkets like Wal-Mart (NYSE:WMT), Carrefour, Costco (NYSE:COST), etc. for households’ bulk grocery shopping. Drugstores buy and store food in smaller quantities and less efficiently due to higher logistics costs (for instance, smaller volumes transported from warehouses to stores) and higher property rental rates in urban areas. As a result, customers might pay a little extra at the register for groceries at these locations.

How does this impact CVS?

Higher traffic at stores

People shop for food on average about 2.5 times a week compared to roughly monthly visits to a drugstore. ^[2] Hence, offering groceries at drugstores translates into markedly higher foot traffic.

While the gross margins from grocery sales are at about 18%, much lower than margins for retailers in general at over 30%, the high volume of sales makes selling groceries significantly profitable. The higher traffic also increases the sales of over-the-counter drugs, cosmetics and personal care products, which is another important reason stores are pushing ahead in this direction.

Scope for selling private labels

The grocery section also features CVS’ Gold Emblem private-label foods such as pasta, sauces, canned juices and vegetables, snacks, cereals and frozen foods.  CVS not only stands to increase sales from these lower priced substitutes but also earn higher margins on its own private labeled goods versus name brand goods.

The upside for CVS Caremark

We currently estimate the OTC Drugs & General Merchandise (which includes grocery) revenue per square foot at CVS stores to grow at a moderate rate of 2% from $268 in 2010 to $308 in the coming years.

With grocery sales, we can reasonably expect the revenue per square footage to rise to over $350 leading to a 11% potential upside to our current $38 Trefis price estimate of CVS Caremark’s stock.

You can drag the above graph to see the impact on CVS Caremark’s stock price.

1. Competitive Watch: CVS Expanding Grocery Aisles, Convenience Store News, Jun 08′ 2010 [↩]
2. Stores like Target and CVS Add Groceries To Attract Shoppers, Jan 17′ 2011 [↩] [↩]