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Walgreen Co (NYSE:WAG), the largest drugstore chain, has its stock trading at a two-year high and posted impressive second-quarter results on Tuesday March 19. Let us have a look at the company and see what the company's overall strategy is going ahead.

Background

With annual sales of approximately $72 billion, Walgreen is one of the biggest drugstores in the United States. The company has almost 8500 stores across the U.S. and most dollar income per square foot in the industry with approximately $800 earned per square foot. The general merchandise accounts for $300 of this $800. The company also states that 75% of the U.S. population stays within five miles of a Walgreen store. The company sells prescription and non-prescription drugs as well as general merchandise such as household items, convenience and fresh food, personal care, beauty care and photofinishing. Walgreen also provides pharmacy, health and wellness services, which include infusion and respiratory services, and wellness centers. The prescription sales of the company constitute of 60% - 65% of its total revenue, while over-the-counter sale of drugs and other merchandise accounted for the rest 30% - 40% of the sales.

Second - Quarter results highlights

The company states in its Annual report that its business is seasonal in nature and that the second-fiscal quarter generates a higher portion of revenues compared with the other quarters chiefly due to cough, cold and flu season. Walgreen's (post one-time adjustments) earnings for the second quarter were 96 cents per share compared to 88 cents per share in the same period a year ago. The gross margin of the company was up 1.2% to 30.1%. The gross margin is more than that of CVS (NYSE: CVS) and Wal-Mart (NYSE: WMT). The company's cash and equivalents more than doubled from $1.13 billion at the start of the period to $2.43 billion at the end of period. Net cash provided by operations was $1.8 billion. One major reason attributed to Walgreen's such a good performance was that the company was able to renegotiate its contract with Express Scripts (NASDAQ: ESRX).

Issue with Express Scripts

Express Scripts is a pharmacy benefit management [PBM] company offering healthcare management and administration services. The company effectively works as a middle man between drug makers and employers when it comes to buying drugs. In June 2011, Walgreen and Express Scripts had parted ways owing to disagreement over payment terms. Thus, millions of customers with Express Scripts drug plans had to look for another pharmacy for their drugs. Walgreen's financial performance was certainly affected due to this. In fiscal 2012, the company lost approximately 21 cents a share in earnings. Analysts' estimates peg the revenue loss figure at approximately $4 billion. However both companies resolved their differences and from September 15, 2012 onwards, the customers of Express Scripts were able to buy their drugs from Walgreen. However, a major question that arises is, will all the old customers come back to shop at Walgreen? For example, the biggest beneficiary from this episode was CVS, which was the next best option for the customers of Express Scripts. Will these customers stop going to CVS and come to Walgreen, just because their drug is available again at Walgreen? Although, this reconciliation with Express Scripts also helps reduce uncertainty over Walgreen's contract negotiations with another major PBM, Medco Health Solutions. Medco merged with Express Scripts in April last year.

Acquisitions and Other Major Deals

In June 2012, Walgreen had bought 45% stake in European pharmacy business Alliance Boots. The total deal was worth $6.7 billion of which $4 billion was paid by cash. The company also has a right but not an obligation to acquire the remaining 55% stake by 2015. With this deal, Walgreen plans to create a Trans - Atlantic pharmacy store chain with footprints in 12 countries. It also provided Walgreen a perfect platform to expand internationally, especially further into Asia from Europe. The company has also said that it expects revenue benefits of up to $150 million for the next year and of $1 billion by the end of 2016. However, in the short term, this deal does expose the company to the very risky European markets and volatile foreign currency exchange risk.

In July 2012, Walgreen also acquired regional drug store USA Drug, owned by Stephen L. LaFrance Holdings Inc., in a $438 million mostly-stock deal. The retailer has around 144 stores and includes names such as USA Drug, Super D Drug, May's Drug Stores, Med-X Drugs and Drug Warehouse. Both these acquisitions will increase Walgreen's market presence and will give Walgreen a lot of negotiation power with PBMs such as Express Solutions. Walgreen also acquired Drugstore.com.

Walgreen announced on Tuesday that it had signed a 10-year contract with AmerisourceBergen (NYSE: ABC) as the wholesale supplier of medicines for Walgreen's pharmacies. The deal also gives Walgreen the right to acquire a minority stake of up to 7 percent in AmerisourceBergen. This deal is a big game changer for AmerisourceBergen. In July last year, Express Scripts had signed a three-year deal with AmerisourceBergen. As expected, the shares of AmerisourceBergen increased by almost 5% on Tuesday.

Strong Dividend Program

Walgreen has been issuing regular dividends since the year 1972. And the company has also increased payments for the past 30 years, giving out a dividend of $1 last year. The dividend amount has grown by an annualized rate of 24% over the past five years. A strong dividend program such as that of Walgreen is usually indicative of management's confidence in the company's performance.

Conclusion

The only real road blocks that I see for Walgreen is retail competition and the steps government may take for the U.S. economy. CVS in particular has been showing consistent growth for the past few years. The company's stock has risen by 14.8% over the past 12 months. The company has also merged with Longs Pharmacy and Caremark to give Walgreen stiff competition. Even non-traditional drug retailers such as Wal-Mart have started offering a wide range of drugs. The second concern is that there is a huge debate within the United States on whether the government should cut down on health benefits being provided by it to reduce its fiscal deficit. However, with Walgreen trying to expand organically and through global acquisitions, it is trying to insulate itself from local factors such as regulations and completion. Thus, Walgreen looks in a good position to grow in the long run.

Source: This Drug Store Is On An Expansion Spree