Is the Optimism in Walgreen Warranted?

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The decline in revenues and operating profitability based on the last fiscal quarterly report of Walgreen (NYSE: WAG) didn’t seem to adversely affect its stock price. Many analysts claim the fallout the company had with Express Scripts (NASDAQ: ESRX) is the main factor for the company’s poor growth in revenues and drop in profitability. The recovery of the company’s stock in recent months as the dispute with Express Scripts had ended shows a vote of confidence Walgreen’s investors have in the company. Is this confidence founded? Let’s examine the company’s performance and try to figure what is next for Walgreen.

According to the company’s fourth quarter (for the fiscal year) financial reports; Walgreen’s revenues fell again compared to previous quarters: the quarterly revenues declined by 3.8% compared to the third quarter and by 5% compared to the same quarter in 2011. The operating profit, even more than the revenues, tumbled by nearly 33% compared to Q3 2012 and by 53.7% compared to Q4 2011. The diluted earnings per share of the company reached in the last quarter $0.63. The current expectations of analysts are around $0.69 for the next quarterly report, which represents nearly 10% growth compared to the previous quarter. I think this figure is a bit too optimistic. Let's see why:    

Despite the end of the dispute between Walgreen and Express Scripts the process of winning over the clients, who have left Walgreen for other companies, is likely to be long and far from easy. According to the September sales report the company’s sales declined again by 7.8%.  I still think Walgreen will continue to suffer from its fallout with Express Scripts in the months to follow, which could further pull down the company’s revenues, profits and profitability.

Further, the economic slowdown in the U.S won’t help the company’s growth in sales. Even though there was a rise in retail sales in recent months, a close examination of the detailed report reveals sales in Health and Personal Care Stores increased by only 1.5% during the first nine months of the year compared to the same period in 2011. This type of business rose by only 0.4% during September compared to August 2012 and fell by 0.1% during August compared to July. These figures suggest the entire Health and Personal Care business didn’t expand much during the year as a whole; therefore Walgreen will be fighting to bring back customers in a business that only slightly grew during the year and in recent months. If the industry will continue to moderately rise, then the prospects of the sharp growth in Walgreen's earnings seem less likely.

On the other hand, perhaps, Obamacare will help the company’s revenues by bringing more patients from hospitals to Walgreen’s stores. Finally, the company continues to seek out new territories and expand its operation: it recently completed an acquisition of a regional drugstore in the mid-South. If the company will continue to expand its operations, this could also help the company's earnings growth in the future. 

As seen in the chart below the company has managed to recover from its tumble during June of this year and is currently very close to the growth rate of the market as the S&P500 index hasn’t substantially outperformed the company year-to-end.

<img src="/media/images/user_12845/walgreen-and-sp500-index-2012_1_large.jpg" />

The company hasn’t outperformed its competitors as its operating profitability is very close to the operating profitability of CVS Caremark Corporation (NYSE: CVS) as indicated in the chart below. Further, the operating profitability of Walgreen has had a downward trend in recent quarters and as of the recent quarter its operating profitability was only 3.4%.  In comparison, the company’s operating profitability in the parallel quarter in 2011 reached 7%.

<img src="/media/images/user_12845/walgreen-and-operating-profitablity-2012_large.jpg" />

At least in terms of dividends the company is offering a reasonable yield with respect to its low operating profitability and with respect to other related companies and competitors. Currently, Walgreen is offering a quarterly dividend of $0.28 per share which reflects a yearly dividend yield of 3.1%. In comparison, CVS Caremark is currently paying a quarterly dividend of only $0.16 per share or an annual yield 1.41%; Rite Aid Corporation (NYSE: RAD) doesn’t offer any dividend since the company isn’t showing profit.

The Foolish bottom line:  

Despite the recent optimism towards Walgreen, I still think the company’s revenues and earnings won’t show much growth in the near future. The company’s decision to expand its operations, the effect of Obamacare, and the renewed collaborations with Express Scripts might help Walgreen’s revenues in the future but this is likely to take time until it will be seen in the company’s financial results.

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liorc has no positions in the stocks mentioned above. The Motley Fool owns shares of Express Scripts. Motley Fool newsletter services recommend 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.If you have questions about this post or the Fool’s blog network, click here for information.

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