Better Buy: CVS Health Corporation vs. The Kroger Co.

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It isn't easy to find value in today's market. However, CVS Health (NYSE: CVS) and Kroger (NYSE: KR) stand out as two glaring exceptions. Both of these stocks have been hammered over the last year and are trading at a steep discount to the S&P 500.

But which of these retail titans is the better buy today? Let's review the bull case for owning each of them to see if we can identify a winner.

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The case for CVS Health

Most investors think that CVS is just a retail pharmacy chain. In truth, that's less than half of the story. CVS also operates the second-largest pharmacy benefits manager (PBM) business in the country. Let's dissect the growth story for each, starting with CVS.

CVS Health operated more than 9,750 retail pharmacy stores as of the end of 2017. While the company continues to open new stores, it has faced a number of challenges that have caused same-store sales comps to remain weak (most notably reimbursement headwinds and higher sales of generic drugs). On the plus side, the company's in-store MinuteClinics offer investors reason to believe the company can continue to pull in foot traffic and keep online competitors at bay.

Turning to the PBM business, CVS operates as an intermediary between drugmakers and entities that provide healthcare (employers, governments, unions). CVS uses its huge bargaining power to buy drugs in bulk at a discount and then shares the savings with its clients. Given the rampant growth in drug prices over the last few decades, this business has been a strong driver of revenue growth for the company.

As if running a massive retail empire and PBM business wasn't enough, last year, CVS announced its intention to enter the health insurance market, too. The company recently agreed to pay $69 billion to acquire Aetna (NYSE: AET). For perspective, CVS Health's current market cap is $63 billion, so the Aetna deal represents a truly massive bet. If the deal goes through, it would be the biggest acquisition in the company's history.

If everything goes according to plan -- which is a huge if, mind you -- then CVS Health could be poised for turbo-charged growth in the years ahead. Management had previously forecasted double-digit profit growth between its retail and PBM businesses. Adding Aetna to the mix could upsize that number significantly, especially when considering the potential for synergies.

When layering in the gradual graying of the American population, it appears that CVS bulls have reason to believe the wind is at this company's back. Meanwhile, shares offer up a dividend yield of 3.2% and are trading for less than 10 times next year's profit estimates. If the company can deliver on its growth promise, then shares look like a steal today.

The case for Kroger

You might not realize it, but Kroger is actually the second largest grocer in the country. The company has been an acquisition machine over the last few years and now counts brands such as Roundy's, Harris Teeter, Fred Meyer, King Soopers, and more in its empire.

While M&A has certainly helped this company grow, Kroger's existing stores have been carrying the weight, too. The company has placed an emphasis on prepared foods and has tacked on pharmacies, gas stations, and more to its stores. These factors have allowed the company to post strong comp gains for more than a decade.

As if that wasn't enough, Kroger is also finally starting to get serious about beefing up its e-commerce capabilities. Using its treasure trove of customer data, the company is starting to roll out its order-and-pickup features in stores. The company's in-store "Scan, Bag, and Go" program is also showing traction, and management has announced plans to offer the program in hundreds of stores.

Finally, it's also worth mentioning that the recent tax cuts should be a boon for Kroger's bottom line. The company's historic tax rate is north of 30%. The company estimates that this number will fall to 22% in the year ahead. That might sound like a small difference, but it actually represents hundreds of millions in tax savings that the company can use to reward shareholders.

Kroger managed to grow its EPS by 9% annually over the last five years. When factoring in all of the above, market watchers expect mid-single-digit growth over the next five years. While that's not a blazing-fast number, Kroger's stock is trading for less than 11 times forward earnings and offers up a dividend yield of 2.1%. Those figures could be attractive enough to allow shareholders to come out ahead, even if EPS growth remains modest.

Reasons for caution

Kroger and CVS Health both look cheap, but there are big reasons Wall Street is pricing them at huge discounts.

One big problem facing CVS Health is that it recently lost a substantial amount of business to Walgreen Boots Alliance. That raises concerns that its business isn't as competitive as it should be. Furthermore, rumors that Amazon (NASDAQ: AMZN) has taken an interest in the healthcare industry were recently confirmed, which represents a serious long-term threat to the company. Finally, it is notoriously difficult to make large-scale acquisitions like the pending Aetna deal work out. When combined, I understand why Wall Street feels that extreme caution is warranted.

The story looks quite similar at Kroger. Amazon recently entered the grocery market in a major way last year, when it purchased Whole Foods. To combat the threat, Kroger finally decided to start taking its e-commerce business more seriously, but it's possible that it could be too little, too late. What's more, the company is leaning on price cuts as a way to keep its existing customer base loyal. That's pinching margins and is a reason profit growth is expected to be anemic.

The better buy

While I have a hard time calling either of these companies a screaming buy right now, when forced to choose, I'd happily take Kroger. CVS Health's pending Aetna deal wreaks of desperation and will likely be a huge challenge to integrate. Meanwhile, the company isn't ramping up its MinuteClinic network expansion at the pace I had expected, so it's possible the concept is not pulling in new traffic at an acceptable rate.

There's no doubt that Kroger is facing its fair set of challenges, too, but I have simply have much more confidence in its ability to execute its game plan in the years ahead. That's why I think Kroger is the better bet today.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Brian Feroldi owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends CVS Health. The Motley Fool has a disclosure policy.