Walgreen (WAG) reports fiscal Q3 2013 earnings before the opening bell Tuesday, June 25, 2013, with analyst consensus expecting $0.91 in earnings per share (EPS) on $18.5 billion in revenues, for expected year-over-year growth of 4% and 44%, respectively. Fiscal Q3 2013 comparisons (comps) are expected to be 2%-3%, continuing a below-average trend of disappointing comps. Since WAG still reports monthly numbers, in April 2013 WAG's front-end comps declined 4.3% (distorted by Easter) while May comps were 1.2%.
The retail dug store business has changed markedly over the last 13 years, first with the CVS (CVS) purchase of Caremark, entering the PBM business in a big way, and lately with WAG's merger with Alliance Boots (A/B) and its big foray into England. Then, with the March 2013 earnings report, WAG announced a 10-year deal with Amerisource Bergen (ABC), which will allow ABC to help WAG with daily drug distribution, but WAG will also (supposedly) get the ability to increase the sales of specialty generic drugs. To me, it seems as if the retail business model of the 1980s and 1990s where pharma and prescription customers walked into stores to get prescriptions filled and then bought "convenience items" -- which is a higher-margin business for the stores -- is morphing into a managed-care, "get more of the customer's healthcare dollar" type of a model.
Here are a couple of longer-term trends we are watching:
- The "front-end" convenience item comp has been eroding for retail drug stores since the late 1990s. Back in the day (in the late 1990s), WAG and CVS used to put up mid-single-digit front-end comps for years, with the high end at 8% and the low end at 2%-3%. Today 2%-3% is the norm, and this has hurt profitability.
- The wave of generics over the next few years will offset some of the lost profitability at the front-end, as generic drugs sport margins that are higher than brand-name drugs.
- Minute clinics and take-care clinics where customers can walk in and get their medical needs met without incurring the expense of a doctor visit are an example of how the traditional retail drug store model is evolving. See a qualified medical person inexpensively and get a scrip filled all at the same time.
- The whole melding of the retail drug-store model with pharmacy benefit management and drug distribution and then laying managed care and Obamacare on top of it all has me feeling like much of this will continue to play out over the years -- and I don't have a good understanding of it.
So, where does that leave us with WAG? Since bottoming in late June/early July 2012 under $30, and with the resolution of the Express Scripts (ESRX) fiasco, WAG has rallied 62% since that time. Thus, in my opinion, the stock is fairly valued and we'd like to repurchase it lower.
Trading at 15x expected 2013 EPS estimates of $3.27 and 13x the fiscal 2014 estimate of $3.70, WAG is expecting EPS to grow 12% and 13% over the next two years, respectively. Revenue growth is expected at 1% and 5%, respectively. WAG is trading at 9x cash-flow with a 2.2% dividend yield.
Our internal model values WAG at $52 per share, while Morningstar values WAG at $35 per share. Even with our aggressive earnings-based model, WAG is fully valued. Splitting the difference between our internal model and Morningstar's fair value, we would actually be more interested in buying the stock in a quantity closer to $40.
WAG's stock has been a lesson in frustration over the last 13 years, after topping out with the rest of the large-cap growth universe in March 2000 near $50 per share. With the whole ESRX mess, the Alliance Boots acquisition, and now the ABC deal, WAG's management is trying to reshape the company to meet the healthcare environment the next 20 years. There has been a large "uncertainty" premium in the stock for quite some time. Maybe it is dissipating, but we would like to own WAG 20% lower -- despite some of the headwinds and uncertainty fading.