Walgreen: Can Scaling Back Boost Profits?

By Chris Barella

As the current recession continues to dig deeper into companies' bottom lines, higher costs and lower profits equals contraction rather than growth.

Walgreen Co. (WAG) reported earnings on Tuesday, and a 5-cent miss sent shares reeling throughout another tough day for Wall Street. One of the countriy's largest drugstore companies, behind industry leader CVS (CVS), Walgreen reported earnings for the the third quarter ending on November 30 of 41 cents per share on sales of $14.9 billion. (See earnings call transcript.) Net earnings for the last quarter were down more than 10 percent to $408 million compared with $456 million or 46 cents per share. Analysts were expecting 46 cents per share with $15.1 billion in sales.

Even though overall store sales were up 6.6% over the last 3 months, higher selling, general, and administrative costs related to the opening of a record 212 new or acquired stores throughout the quarter. Gross profits were also hurt by an increase in the LIFO provision to $43 million in this year’s quarter, versus a provision of $27 million in last year’s first quarter.

In response to the tougher economic conditions, Walgreen plans on reducing further new store openings to 4 - 4.5% in 2010 and 2.5 - 3% in 2011 to save an additional $500 million in capital expenditures beyond the $500 million announced in June. Plans for store openings have been cut further after a 5% organic growth rate was announced back in July, to allow for more savings. The goal is to utilize the savings from fewer store openings by remodeling and renovating current stores as well as expanding merchandise variety to take full advantage of already well-established operations. With online sales at Walgreens.com up 45% in November and prescription sales up 6.6% during the quarter, Walgreens has been able to maintain its strong industry position. Walgreen’s CEO, Gregory D. Wasson, commented:

We continue to post solid sales results and achieve strong cost control in this difficult retail environment. Customer traffic strengthened through the quarter and we’re making substantial progress on our growth strategies to get more from our core operations and enhance the customer experience.

On top of cutting back on store expansion over the next couple of years, Walgreens has implemented their Rewiring for Growth and Power initiatives, which are designed to enhance patient-pharmacist interaction and reduce costs in the areas of indirect procurement, general overhead, and labor. Their goal is $1 billion in total costs savings by fiscal 2011. The first quarter results were negatively impacted by 1 cent per diluted share related to Rewiring for Growth one-time costs.

CEO Wasson added:

We believe that further slowing of organic store growth is a prudent step in the context of current economic conditions. Furthermore, by freeing up human and financial capital, substantial upside exists to drive greater value creation by enhancing the best community-based store network in America. This includes refreshing and remodeling existing stores, more efficient assortment within stores, prescription file buys and continued expansion of retail and worksite clinics.

Though consumers are cutting back, drug stores and discount retailers are still hanging tough. Even with Walgreen’s miss showing that discount retailers are feeling the pinch, CVS showed some strength as they rallied back after a steep drop and reiterated their earnings guidance for fiscal 2008.

It’s obvious that Walgreen’s increased SG&A expenses are on the rise due to store openings and the demand simply is not there for their historic store growth for the next couple of years. I anticipate profits to be under more pressure going into 2009, with further lowering of growth estimates possible going forward.

Disclosure: None

Comments

[Brad Castro:]

I think Walgreens is a terrific business. They basically operate upscale convenience stores, sell drugs, and (in some states) are also liquor stores. I have to believe that the digital photo processing operations are high margin as well and God knows I've given them enough business there.

The dividend is too low to attract me as an investor, however, and historically, the stock hasn't been volatile enough for effective option trading strategies.

I think WAG would be an incredible business to own outright, but there's not much you can do with individual shares except buy and hold and hope for the best.

2008 Dec 27 10:43 AM

[notsosmart:]

anybody think of millions paid fo medicaid fraud. blamed on accounting errors of course.LOL.

2008 Dec 27 12:08 PM

[107Sid:]

Doesn't the long-standing demographic argument about the impact of the aging boomers still provide a favorable underlying backdrop even though the enterprise is now fairly mature?

2008 Dec 27 01:34 PM

[sylviechen:]

It would be interesting to determine the profit margins by product by shelf.
I suspect that cosmetics and pharma products are the core of their profits with convenience items as well as household supplies a distant second.
They need to better monitor their margins based on price optimization software.
Do they really need to continuously promote cheap t-shirts and sports stuff that cannot compete with the likes of Target and WalMart?. It's one thing to be a one stop shopping experience but their store size does not support such an inventory of product channels. As someone recently said: "you can't fix stupid".

Walgreens, back to school for a refresher on profitability! CVS may clean your clock as they already did with Long's Drugs. They also need to move away from shopping inserts and follow the Costco model of select products online with store pickup. That is the most efficient way to handle inventory and space.

2008 Dec 27 07:32 PM

[WagDoll:]

Greg Wasson is COO and president - not CEO (at least not yet).

2008 Dec 29 10:16 AM

[roudy11z@ai...:]

Wal-Green's needs to lower its prices overall on non pharmacy items. It is obvious to anyone that most items are over priced compared to Wal-Mart. CVS seems to be higher also. This should be obvious to the CEO and directors at Wal-Green's.
Roudy McLovin

2008 Dec 29 04:37 PM

[WAGInThe Know:]

Those "cheap T-shirts " generate amazing profits! My store alone made about $20,000 in profit the past 4 months from the sales of college and high school clothing.

Jan 19 07:49 PM