Walgreen: Strategically Strong if Tactically Weak
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The usual suspects, those who didn't see the miss coming, immediately downgraded the stock as though that would help traders who were caught out guard.
But note I said traders, not investors.
Walgreen's strategy makes sense
Walgreen is engaged in a long-term re-invention which, it hopes, will make it a big winner in health reform.
This is driven by two key facts. There's a growing, and chronic, shortage of general practice physicians. And high-income consumers are increasingly unwilling to wait all day in a waiting room anyway.
The result is a redesign of all its stores built around its Take Care Clinics, staffed by nurses and physicians assistants, linked to doctors through electronic health records and the Internet. The company has managed to get permission to diagnose and treat “chronic conditions” like diabetes through the clinics, and has made deals with countries like Chile to treat their nationals as part of those countries' health plans.
The strategy goes further, transforming Walgreen's stores from convenience shopping into lifestyle hubs complete with wine and coffee bars, even massages, so that any wait for care, for diagnosis, or for drugs becomes a joy instead of a chore.
This is a long-term change. In the Atlanta market, for instance, only three of the company's stores now feature the clinics. The first of the redesigned stores just opened this year in Chicago. We're talking about a five-year plan that will unfold along with health reform. It's not political, it merely takes advantage of what politics has wrought, but those who don't like the politics are bound to be leery of it.
Walgreen put the best face on the news, emphasizing the fact that earnings were $645 million rather than the fact that revenues were up only 3.2% to $18.3 billion. Analysts preferred to harp on its long-term argument with ExpressScripts, the pharmacy benefit manager which cut it off from its customers for nearly a year over a financial dispute, which was settled last year.
Traders also expressed some distrust of the company, one reporting that someone dropped 12 million shares on the market right before the earnings came out.
The point is these are all tactical points, not strategic ones. The ExpressScripts problem is in the rear-view mirror. Any long-term plan is going to go through short-term hiccups.
CVS stands pat
Those who dislike Walgreen may find their ease with CVS Caremark (NYSE: CVS), the company's main rival.
While CVS has its own clinic unit, MinuteClinic, the company has kept that group on a short leash, preferring to offer typical “doc in a box” services like wound care, rather than go at the heart of the medical business. CVS stores look today much as they did 30 years ago, with household and beauty items on head-high shelves, along with convenience goods. The idea is that you come in with your prescription and leave within a very short time – there are even drive-up windows.
CVS also has its own pharmacy benefit manager, which competes directly with ExpressScripts and is thus closely tied to existing medical practices and business methods. Its most recent earnings report, filed almost two months ago, credited the cold and flu season with a gain in net income from $0.59 per share, $776 million, to $0.77 cents a share or $956 million. This was four cents a share higher than street estimates, and three cents higher than CVS' own forecast.
As a result CVS shares remained fairly stable and, until the Walgreen's release, the two companies traded in tandem.
Rite Aid back in the game
The big news in the space, according to investors, is the return to prominence of Rite-Aid (NYSE: RAD), a competitor many had left for dead.
Since the start of the year Rite-Aid shares have more than doubled in value, currently trading at $2.79, driven by the company's finally righting of its financial ship. For the quarter ending in February Rite-Aid actually had net income, $123 million, on revenues of $6.45 billion, its second straight profit after a long string of losses. The company recorded another profit for its latest quarter, $91 million, on $6.29 billion of revenue.
Credit goes to Ken Martindale, who was named president alongside the latest earnings. Martindale, who joined from Pathmark in 2008, basically went back to drug store blocking-and-tackling. The stores look similar to those of CVS, many of them featuring nutrition products from GNC.
Martindale has made a real success here, but how far he can take the company is questionable. There is nothing in his background to suggest anything but an old-fashioned mainline retailer. At its present price the stock trades at a Price/Earnings (PE) multiple of 11.6, meaning it's still relatively cheap.
A little more foot on the gas and you can still make money here on a trade, but that's the best way to play it. Whether it's a long-term holding or eventual take-out bait is unclear.
My Foolish take
Walgreen is not aiming at a short-term win here. If you buy the stock now and it's still near $45 per share in December, it would not be a surprise.
But over the longer term – three-to-five years – Walgreen is the only drug store chain that is changing the industry's game plan. There will be hiccups along the way, as I personally wonder whether wine bars will go with a drug store, but over the longer run it's in a great position to take a much bigger share of the health care dollar than any drug store chain has, ever.
It's an investment, not a trade. Let the traders wash it out and then pick it up, being prepared to hold it for some time before you think of taking profits. Your patience, I feel, will be rewarded.
Dana Blankenhorn has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!