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Healthy Signs for Drugstores

By Sam Stovall The S&P 1500 Drug Retail sub-industry index is a recent addition to the high momentum list.. This group consists of two national drugstore chains: CVS (CVS

; ranked 5 STARS (strong buy); recent price: $53) and Walgreen (WAG

; 5 STARS; $45), and one regional drug chain, Longs Drug Stores (LDG

; 3 STARS (hold); $34). During 2004, this index gained 10.8%, vs. a 10% advance for the S&P Composite 1500. So far in 2005, this sub-industry index jumped 17.7%, while the broader market fell 1.6%.

As can be seen in the accompanying chart, the rolling 12-month relative price performance for this group has exceeded that for the overall market and is in an uptrend. As a reminder, the jagged blue line represents the sub-industry index' rolling 52-week price performance as compared with the 52-week performance for the S&P 1500. Any point above 100 indicates market outperformance over the prior year, while points below 100 indicate market underperformance. The red line is a rolling 39-week moving average, while the two green bands indicate one standard deviation above and below the sub-industry index's 14-year mean relative strength.

Joseph Agnese follows drug retailers for Standard & Poor's Equity Research. "We have a positive investment outlook for the group, which we see benefiting from a favorable demographic environment," he says. "We believe national chains are well positioned, as their pharmacy departments continue to grow in importance, with prescription sales as a percentage of total sales approaching 70% and growing in the mid-teens overall." In addition, nonpharmaceutical sales trends at national chains continue to improve, reflecting better customer service levels and an improving economy, in his view.

However, Agnese believes the shares of regional chains, such as Longs Drug Stores, which derive a majority of their sales from nonpharmacy items, may be pressured by intense competition from both national chains and other retail formats.

Overall, intermediate-term prospects for drug stores are looking brighter, Agnese says, due in part to expectations for moderate economic improvement in 2005, which should continue to benefit sales of nonpharmaceutical merchandise, primarily seasonal and promotional products. Stronger nonpharmaceutical business should reduce gross margin pressure, since such items typically carry wider margins than pharmaceuticals, he says. Profitability should also benefit from increased sales of generic drugs, which carry wider margins than the branded drugs they replace, he notes.

IDENTITY SHIFT. Longer term, Agnese thinks competition should remain intense, as more retail segments recognize the customer draw and profitability of pharmacy sales. Supermarkets and discount-store operators have added pharmacies and beefed up their assortments of health and beauty aid departments, he says. He believes the combination of sharper pricing by the competition, increased low-margin third-party payment plans, and lower drug-price inflation is forcing chains to focus on generating more aggressive growth in their core businesses and finding ways to broaden into specialized areas.

Since the challenges imposed by these competitors will likely intensify, Agnese sees the industry fashioning a more proprietary identity based on comprehensive selections of basic health and beauty aids and over-the-counter products, as well as in-and-out shopping convenience.

So there you have it. From both a fundamental and momentum standpoint, S&P believes the investment outlook for the S&P Drug Retail group is favorable over the coming 12 months.

Industry Momentum List Update

For regular readers of the Sector Watch column, here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500), their proxies (the highest STARS-ranked companies in the sub-industry index-tie goes to the largest market value) as of March 18, 2005.





Recent Price

Commodity Chemicals

Lyondell Chemical




Drug Retail





Fertilizers & Agr. Chem.

Scotts Co.




Home Ent. Software

Electronic Arts




Integrated Oil & Gas

Exxon Mobil




Managed Health Care





Oil & Gas Drilling

Nabors Industries




Oil & Gas E&P

Devon Energy




Oil & Gas Refg., Mktg. & Trans.

Valero Energy





Burlington Northern Santa Fe





Carpenter Technology





CNF Inc.




Required Disclosures

5-STARS (Strong Buy): Total return is expected to outperform the total return of the S&P 500 Index by a wide margin, with shares rising in price on an absolute basis.

4-STARS (Buy): Total return is expected to outperform the total return of the S&P 500 Index, with shares rising in price on an absolute basis.

3-STARS (Hold): Total return is expected to closely approximate the total return of the S&P 500 Index, with shares generally rising in price on an absolute basis.

2-STARS (Sell): Total return is expected to underperform the total return of the S&P 500 Index and share price is not anticipated to show a gain.

1-STARS (Strong Sell): Total return is expected to underperform the total return of the S&P 500 Index by a wide margin, with shares falling in price on an absolute basis.

As of December 31, 2004, SPIAS and their U.S. research analysts have recommended 26.5% of issuers with buy recommendations, 61.3% with hold recommendations and 12.2% with sell recommendations.

All of the views expressed in this research report accurately reflect the research analysts' personal views regarding any and all of the subject securities or issuers. No part of the analysts' compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.

Additional information is available upon request to Standard & Poor's, 55 Water Street, New York, NY 10041.

Other Disclosures

This research report was prepared by Standard & Poor's Investment Advisory Services LLC ("SPIAS"), and may have been provided to you either by: (i) Standard & Poor's under a license agreement with The McGraw-Hill Companies, Inc., which holds the copyright to this report; or (ii) a Standard & Poor's client who is granted a sub-license by Standard & Poor's. This equity research report and recommendations are performed separately from any other analytic activity of Standard & Poor's. Standard & Poor's equity research analysts have no access to non-public information received by other units of Standard & Poor's. Standard & Poor's does not trade in its own account. SPIAS is affiliated with various entities, which may perform services for companies covered by the recommendations in this report. Each such affiliate is operationally independent from SPIAS.


This material is based upon information that we consider to be reliable, but neither SPIAS nor its affiliates warrant its completeness or accuracy, and it should not be relied upon as such. Assumptions, opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results.

This material is not intended as an offer or solicitation for the purchase or sale so any security or other financial instrument. Securities, financial instruments or strategies mentioned herein may not be suitable for all investors. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation of particular securities, financial instruments or strategies to you. Before acting on any recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Stovall is chief investment strategist for Standard & Poor's

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