Look for Opportunity in Walgreen

Nidhika is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Walgreen (NYSE: WAG), the largest drugstore retailer in the US, saw its biggest intraday fall (more than 7.5%) after it released its third quarter results. Though Walgreen gained 16% in revenues and 29% in adjusted earnings, it was caught short of the market expectations and also lost some ground on the same store sales. Walgreen, however, should not be looked down upon. It is a strategically solid stock, with a forward approach, and hence should be looked out for good opportunities.

Walgreen, with more than 8,000 drugstores in the US, is engaged in retail sales of drugs, personal care products, supplements and other general merchandise like household goods, candies, etc. The company is based on the strategy of providing convenient access to healthcare services, which it provides through mail, telephone and the internet. It also operates Take Care Clinics, which, through more than 700 in-store clinics, provides medical treatment to patients including vaccinations.

Last year, in a cash-and-stock deal, Walgreen acquired a 45% stake in Alliance Boots, UK’s largest drugstore chain for $6.7 billion. The US and UK retailer, through the synergies offered by this deal prospect to pursue profitable growth and international expansion. Its forecasts include huge benefits from sharing best practices in store structuring, customer loyalty programs and e-commerce business. During May 2013, Alliance Boots released their annual results, posting an increase of 6% in annual earnings.

Numbers & financials

Walgreen posted third quarter revenues of $18.3 billion, an increase of 3.2%, driven mainly by prescription sales volume, offset by 3.9 % decrease in customer traffic in comparable stores. Gross Profit increased by 4.1% to $208 million, driven by increase in sales of high margin generic drugs, partially offset by increase in selling, general and administrative expenses by 5.3%.

Walgreen posted a GAAP-determined Net Earnings of $624 million (EPS of $0.65). However, non-GAAP adjusted net income for the quarter stood at $812 million (up by 29.3%), thereby computing an EPS of $0.85. The adjustments referred to one time legal settlement costs, negative impact of the LIFO provision and other one-time items linked to amortization, taxes and costs related to acquisition of Alliance Boots.

A 3% revenue growth is not exciting for a pharmaceutical company, which is a market leader. Moreover, there has been a drop in same store sales, which reflects that something went wrong.

What seems wrong?

Walgreen President and CEO Greg Wasson said, "Our front-end sales are still not up to our expectations, and while the economy remains challenging, increasing customer traffic and front-end sales are our near-term priorities with a focus on pricing and promotion and the leveraging of our Balance Rewards program, which now has 75 million members."

It is evident that while attempting to get more on its plate, the company missed out on what’s falling off. Walgreen has its strategies right in place regarding the expansion, synergies and buying out smaller players. But, while getting them right, the company sidetracked the regular promotional activities much required to maintain a healthy growth in the comparable store sales and customer traffic.

The company needs to take action immediately to improve its front end sales and drive store traffic, by speeding up its promotional activities, leveraging on its loyalty programs, and increase in further sales of generic drugs. The company got an increase in its retail pharmacy market share by 80 basis points, and needs to grow this segment further.

Other Players

In such scenarios, it looks tempting to avoid Walgreen and invest in stocks like Rite Aid (NYSE: RAD), CVS Caremark (NYSE: CVS) and Express Scripts, especially after the Walgreen – Express Scripts fiasco.

Rite Aid recently reported its results, with marginal increase in same store sales. It reported its highest profit margins in the last last 7 years. Moreover, its customer loyalty program and customer satisfaction levels ensures repeat customers. However, Rite Aid seems to have a cautious outlook, as it is planning to close down some stores and also remodel some.

CVS Caremark, one of the fastest growing chains, opened 28 new stores in its last quarter and aims to open 150 new stores in 2013. It benefited the most from the Walgreen – Express Scripts fiasco in fiscal year 2012, and expects to continue benefiting from it. CVS Caremark seems to be banking on its Minute Clinic concept, wherein it shall have doctors to diagnose minor illnesses. However, this seems to be quite similar to the Take Care Clinics operated by Walgreen.

Bottom Line

Walgreen definitely seems to be lost in the pool of its own strategies, but it still is a market leader. It has an aggressive outlook, and is strategically sensible. Its prevention of advertising can also be cited as a cost control attempt, which proved wrong. However, given the resources, huge cash flow, synergies and the expertise held by its management, a few correct steps taken by Walgreen can bring it back in the game, and how. It can be opined to hold the stock if you're already invested. Otherwise, it would be suggested to look for the good opportunities to enter a position in this stock, as Walgreen is strategically sound and reliable.

Nidhika Goyal has no position in any stocks mentioned. 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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