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Walgreen (WAG) reported earnings on Tuesday and ended the day up over 5% on a down day for the market. Amazingly, the company did it on a revenue miss, with analysts expecting revenues of about $19B, compared to the $18.7B reported.

So why did the stock jump? And why don't I buy it? Several reasons:

WAG reversed a recent history of earnings misses

Walgreen had missed on earnings for the last two quarters, with four straight quarters of negative earnings growth.

PeriodEstimateActualVariancePrevious Year
Q1 2013$ 0.70$ 0.58-0.12$ 0.63
Q4 2012$ 0.56$ 0.53-0.03$ 0.57
Q3 2012$ 0.62$ 0.630.01$ 0.65
Q2 2012$ 0.77$ 0.780.01$ 0.80
Q1 2012$ 0.67$ 0.63-0.04$ 0.62
Q4 2011$ 0.55$ 0.570.02$ 0.49

That changed Tuesday - the company reported an EPS of $0.96, more than 20% better than last year. The huge jump was mostly due to increased efficiency and gross and operating margins were way up over previous years.

The Street has been a little leery of WAG, but the company looked strong for the first quarter of the year.

The company announced a major supplier deal

The company announced a major supplier deal with AmerisourceBergen (ABC), a major pharmaceutical wholesaler. The companies agreed to a 10 year distribution agreement, which should have allowed WAG to negotiate for better pricing.

However, Walgreen executives barely mentioned pricing power. WAG gets the right, but not the obligation to purchase up to 7% of this fully diluted equity of AmerisourceBergen in the open market, which they will do. In addition, AmerisourceBergen grants Walgreen equity warrants exercisable for 16% in the aggregate of the fully diluted equity of AmerisourceBergen. Effectively the combined companies are the biggest drug buyers in the world, which should allow them to get better pricing than their competition.

The Bear Case

There is still a strong bear case to be made coming out of this, though. On the earnings call, Walgreen announced they are still seeing negative same-store sales growth: all non-prescription sales were down on the quarter. And clearly, a lot of the strength in prescription sales were due to a really strong flu season this year.

Additionally, in response to questions on the call, the CEO Greg Wasson admitted that the deal won't have any impact on working capital in the near term. I think this is the primary reason that WAG got the warrants: most of the economic value in this deal is going to ABC, and WAG wants to participate. But now WAG is a stakeholder in a wholesaler, which means that any alternatives for their supply chain are pretty much out the window: if I were another wholesaler, I wouldn't reveal true pricing to WAG even if they promised a small order.

Furthermore, WAG looks expensive compared to comps like CVS (CVS) and Wal-Mart (WMT). Admittedly the company has slightly better operating margins, but not so widely superior that I think they're justified (numbers from Yahoo).

TickerGross MarginsOp MarginsPEPS
WAG0.290.0520.240.57
CVS0.180.0617.980.53
WMT0.250.0614.440.52

Admittedly, WAG had a strong quarter, operationally and strategically. But it looks to me like this is a lot of ado about a great quarter for the flu, and a great deal for ABC. I would fade this rally and look for CVS, which is bound to try to sign a similar deal, possibly with one of ABC's competitors.

Source: Walgreen Earnings And Stock Pop: What Just Happened