Walgreen: Bargain or Dud?

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Could America’s largest drugstore chain be a good value play in the retail sector? Walgreen (NYSE: WAG) has lost a lot of customers to arch rival CVS Caremark (NYSE: CVS) because of a conflict with Express Scripts (NASDAQ: ESRX) over the spring and summer. Walgreen refused to process Express Scripts prescriptions, which caused large numbers of customers to switch to CVS.

CVS Caremark saw its net income rise by 16%, or 1.01 billion due to the debacle, yet Walgreen has now mended fences and is processing Express Scripts prescriptions again. Not surprisingly, value investors are beginning to wonder if Walgreen is a classic value buy; is it a good company beset by a one-time problem that has been solved?

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If you like dividend stocks, the answer seems to be yes. As you can see above, Walgreen has a fairly high dividend yield for a retailer, and that dividend yield has been going up for well over a year. In terms of dividends, Walgreen certainly beats out its competitors. Despite its rise in income, CVS Caremark only offers a dividend yield of 1.4%, while Rite Aid (NYSE: RAD) and Express Scripts don’t pay any dividends at all.

From a dividend point of view, Walgreen is a certainly a bargain, but does it have anything else going for it? Well, yes, Walgreen seems to have a lot of cash, but not as much as CVS Caremark. As of Aug. 31, Walgreen’s net income was $2.127 billion, which was actually higher than Express Scripts’ net income of $1.054 billion. Although it was over $1 billion lower than CVS Caremark’s net income of $3.67 billion, Walgreen is doing far better than Rite Aid, which reported a net income of -$290 million.

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As you can see, Walgreen's net income took a substantial drop this year because of its dust up with Express Scripts. Since that conflict is over, we might expect Walgreen's net income to start rising again. The only problem is that it may take some time for Walgreens to recover. Even though it settled the fight with Express Scripts in July, Express Scripts customers were not able to start coming back to Walgreen until September.

The situation might be made worse by the fact that Walgreen may have to resort to loss leaders and giveaways to lure the Express Scripts customers back to its pharmacies. In other words, it’ll have to spend money in the hopes that it can win back at least some of the lost customers.

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The problem is that such a strategy might eat up a lot, if not most, of Walgreen's cash. The company had around $1.29 billion in cash and ST investments on Aug. 31, down from $2.5 billion a year before. That indicates that Walgreen had to dip into its savings to make up for some of the losses from the Express Scripts conflict. It also means that Walgreen may not have the cash necessary to lure back those customers.

Many of those customers are probably gone for good because of all the competition in the drugstore business these days. In addition to CVS Caremark and Rite Aid, Walgreen has to contend with big discounters like Wal-Mart and Target, grocers such as the Kroger, and club store operator Costco. All these companies operate pharmacies, and many of them use prescription drugs as a loss leader to lure customers in the door. A company like Wal-Mart or Costco can afford to practically give some cheaper pharmaceuticals away because they are not that company’s primary business.

If that wasn’t bad enough, Walgreen is also facing aggressive competition from fast growing dollar store chains like Family Dollar and Dollar General. These companies compete directly with Walgreen in every retail segment except prescriptions.

Walgreen is certainly a good company with a lot of cash on hand, but it’s in a real rough spot right now. If you’re looking for a low-priced diamond in the rough to buy and hold, it might be a good fit. If it can figure out how to come back, Walgreen is certainly a value buy, but if you’re looking for steady gains in retail, Wal-Mart or Costco might be a better fit. 

StockCroc1 has no positions in the stocks mentioned above. The Motley Fool owns shares of Costco Wholesale and Express Scripts. Motley Fool newsletter services recommend Costco Wholesale and 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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