Is European Expansion a Good Strategy?
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The recent rally of Walgreen Co. (NYSE: WAG) came soon after the company had settled its dispute with Express Scripts (NASDAQ: ESRX), a dispute that held back Walgreen for a while. But now the company can focus on developing its future: It was recently announced that the company will form a strategic alliance with Alliance Boots in order to create a first global chain of pharmacies. Is this the right move for Walgreen? Let's explore this issue and the current condition of the company.
Walgreen has several strong points: it shows solid profits; the company gives a high dividend compared to other companies in its industry; it recently settled its dispute with Express Scripts; and Walgreen is in the process of expanding into Europe, an expansion that could entail additional growth for the company.
The announcement of Walgreen to raise its dividend to $1.10 per share, which represents an annual yield of 3%, is reasonable and even high for the industry. As a comparison Caremark Corporation (NYSE: CVS) offers a dividend of only $0.65 per share or a 1.5% yield; Rite Aid Corporation (NYSE: RAD) offers none since the company is losing money. Considering Walgreen's low profit margins, this line of retuning back cash to investors by issuing dividends is reasonable. This insures the company’s stock will remain attractive if only for its dividend. Since the U.S. bonds have very low rates of less than 1.5% for ten year securities this puts big companies such as Walgreen as a reasonable investment for those who consider it in their retirement fund.
But there are several points that could suggest the company isn’t doing well: during the dispute between Walgreen and Express Scripts these companies lost customers that aren’t likely to return.
Further, despite the solid profits recoded in the third quarter that reached $537 million or 62 cents per diluted share, there was a decline in the company's sales in recent months: sales fell by 6.8% in June, and by 3.7% in July. There was a general slowdown in growth in pharmacies & drug stores sales according to the latest U.S retail sales report. This could suggest the fourth quarter financial reports will show even lower sales and profits compared to the recent quarter.
The chart below shows the normalized prices of Walgreen and the S&P500 during 2012. As seen, the company’s stock performed slightly better than the S&P500 index did.
Further, the linear correlation between Walgreen stock and S&P500 during 2012 reached 0.36, which is mid-weak. This means that only 13% of the stock's volatility (under certain conditions) could be explained by the movement of the S&P500. In other words, the economic slowdown in the U.S. wasn't the main factor to affect the company's stock price movement during the year.
The recent move to “concur” Europe is something that investors may regret: Walgreen invested $6.7 billion in cash and stock in order to buy 45% of Alliance Boots's acuity. Even though this investment has potential growth in places Walgreen hadn’t reached in the past, it also brings new risks; there is a currency risk – the company's activity was in the U.S and this move will expose Walgreen to the fluctuations of the Euro, GB Pound and any other relevant currency. The current economic slowdown in Europe and the debt crisis in many countries put the potential growth at risk.
The Foolish bottom line
One of the main reasons, in my opinion, that made Walgreen a solid investment was its stability, growth in the U.S. and dividends. The dispute it had with Express Scripts didn't help the company and may have shaken its stability. The recent move to expand into Europe and perhaps other markets might eventually prove to be profitable, but it will bring along with it many pitfalls that could adversely affect the company's stability.
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Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.
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