Will This Retail Pharmacy Giant Continue to Rally?

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The fourth quarter (for the fiscal year) earnings reports of Walgreen Co. (NYSE: WAG) showed little growth in revenues and earnings. Will the forthcoming earnings report for the first quarter of 2013 (fiscal year) be any better than the previous earnings report? Let’s examine the company’s performance, try to figure what is next for Walgreen, and analyze its progress with respect to its peers and the market.

According to the recent earnings report, Walgreen’s revenues declined by 5% compared to the same quarter in the previous. Moreover, the company's operating earnings fell by 54% in the previous quarter compared to the fourth quarter in 2011. Will this trend continue in the next quarterly earnings report?

Sales Continue to Decline

According to the recent sales reports for October and November, Walgreen’s sales declined again by 2.1% and 3.9%, respectively. These figures suggest the forthcoming quarterly financial report of the company will present an additional fall in revenues. The company's dispute with Express Scripts is likely to continue adversely affecting the company's revenues.

Moreover, the ongoing economic slowdown in the U.S is also contributing to the contraction in the company's sales. According to the recent retail sales report, total retail sales fell by 0.3% in October.

A close examination of the detailed report reveals the total sales in Health and Personal Care Stores rose by only 1.4% during the first ten months of 2012 compared to the same period in the previous year. Moreover, this sector edged up by 0.3% during October compared to September but declined by 0.5% compared to October 2011. These figures suggest the Health and Personal Care sector in the U.S remained virtually unchanged during the month and only slightly rose during the year. This means, not only Walgreen’s is struggling to expand its sales, but also the entire industry isn't progressing much.  

It's worth mentioning that the company has made several changes in its holdings: the company recently announced it had purchased a partial (but significant) ownership in Cystic Fibrosis Foundation Pharmacy LLC. On the other hand, the company sold its stake in Pine Bluff product distributor. It's still unclear how these changes in assets will affect Walgreen’s operations.

Let's turn to the company's performance with respect to the market and its peers. 

The chart below shows the movement of the company's stock with respect to the market (in this case I have compared it to the S&P500; prices are normalized to the beginning of the year). As seen, despite the sharp movement of Walgreen's stock during the year, it has increased by nearly the same rate as the S&P500 have, mainly due to the recent rally in the company's stock.

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

The company's operating profitability is very similar to one of its main competitors CVS Caremark Corporation (NYSE: CVS). The chart below shows how both of these companies' operating profitability declined by almost half in the recent quarter compared to parallel quarter in 2011. On the other hand, Rite Aid Corp (NYSE: RAD) continues to present a loss from its operations.

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

At least in terms of dividends Walgreen is offering a relatively high yield with respect to other related companies. Currently, Walgreen is paying a quarterly dividend of $0.28 per share which reflects an annual divided yield of 3%. In comparison, CVS Caremark is paying a quarterly dividend of $0.16 per share or an annual yield 1.37%. This high dividend payment might adversely affect Walgreen's stock as it could deter U.S investors from holding shares if the Bush Tax Cuts expire by the end of the year and cause dividend tax rates to jump as high as 43%. Currently, it's unclear what will be of the Bush Tax Cuts as Congress hasn’t reached a decision regarding the multi-year deficit reduction.

The Bottom Line

Despite the recent rally of Walgreen's stock, I still think the company’s revenues and earnings will continue to dwindle in the upcoming quarterly earnings report. Moreover, the entire Health and Personal Care industry is showing little growth, which could also explain the company's lack of growth in sales. Unless the company will change its current situation, perhaps by acquiring another company or expanding to other countries, Walgreen is likely to resume its downward trend.

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