Is Walgreen a Good Stock to Buy?

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In the last year, the stock price of Walgreen Company (NYSE: WAG) has risen 48% following the settlement of its dispute with Express Scripts (NASDAQ: ESRX). The second quarter of the $46 billion market cap retail pharmacy’s fiscal year ended in February, with Walgreen reporting flat revenue compared to the same period in the previous fiscal year. With lower cost of goods sold offsetting increases in SGA expenses, however, the company was able to grow its net income; due to a higher share count, though, earnings per share grew by only a penny. This followed a first fiscal quarter in which results had not been as strong.

The stock trades at 22 times trailing earnings, but if we annualize the $1.23 per share that Walgreen earned in the first half of the current fiscal year we get a slightly lower P/E multiple, and that is with the second quarter of the year significantly outperforming the first (the q/q improvement had been only slight in the last fiscal year, so we don’t think that this was entirely due to seasonal factors). Wall Street analysts expect better numbers in the two remaining quarters, and then still stronger performance in the fiscal year ending in August 2014. Consensus estimates imply a forward P/E of 13. We’d certainly prefer Walgreen to be doing better as things stand rather than being so dependent on future improvements, and perhaps it would be better to watch for another quarter or two of results to see if the company is in fact on track.

Walgreen was one of the most popular healthcare stocks among hedge funds during the fourth quarter of 2012, according to our database of 13F filings (find more healthcare stocks hedge funds loved). Billionaire Steve Cohen’s SAC Capital Advisors reported a position of 1.2 million shares (see Cohen's stock picks). The largest position in the stock out of the filers we track belonged to Orbis Investment Management; that fund, which is managed by William Gray, disclosed ownership of over 7 million shares (check out more stocks Orbis owns).

Walgreen’s two closest peers are CVS Caremark (NYSE: CVS) and Rite Aid (NYSE: RAD). These stocks have also been up nicely in the last year, though Rite Aid’s financials seem to show some struggling. Revenue was actually down slightly in its most recent quarter versus a year earlier, and while earnings did far outperform expectations the stock is still valued very expensively against both its trailing results and forward earnings estimates (the P/E there is 21). CVS carries trailing and forward P/E multiples of 19 and 13, respectively, so it too is getting a good deal of its valuation from expected earnings growth. It’s probably smart to treat that company similarly to Walgreen, waiting to see how results unfold.

We can also compare Walgreen to its partner Express Scripts and to Wal-Mart (NYSE: WMT), which has been getting into the pharmacy game. Express Scripts’ revenue and net income have been up strongly in percentage terms as its relationship with Walgreen has resumed, and in fact if we annualize recent results its own earnings multiple registers in the low teens. With the sell-side expecting further growth going forward, we think it is well worth consideration as a value stock (we’d note that Express Scripts is quite popular among hedge funds). Wal-Mart has been growing modestly on both top and bottom lines, and its business is quite insensitive to the broader economy with a beta of 0.4. At 16 times trailing earnings, it is cheaper than the pharmacies--though it does have less growth potential--yet is valued at a premium to Express Scripts in terms of how well that company has been doing recently.

We think that Walgreen and CVS are both good prospects, but currently the market price is a bit too high for us to recommend buying. It’s best in our view to hold off for now and revisit them once more results come in. The recent financial performance of Express Scripts, however, makes that stock appear to be a good value so we would be interested in researching that company further. 

This article is written by Matt Doiron and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool recommends Express Scripts. The Motley Fool owns shares of Express Scripts. 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!

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