Seeking Alpha
Long/short equity, special situations, value
Profile| Send Message|
( followers)  

Shares of Walgreen (WAG) jumped up following the release of the company's fourth quarter results. Investors are enthusiastic about the deals with Alliance Boots and AmerisourceBergen which start to sort an effect in the coming year, creating more long term upside potential.

Despite the operational improvements and the continued potential I remain cautious in the short term after stellar momentum so far this year. I do still like the long term prospects of the business.

Fourth Quarter Results

Walgreen generated fourth quarter revenues of $17.94 billion, up 5.1% on the year before, and in line with consensus estimates.

GAAP earnings rose by 86.4% to $657 million, as diluted earnings per share rose by 75.9% to $0.69 per share.

Adjusted earnings came in at $0.73 per share, aided by $0.03 per share gains from certain litigation matters. Consensus estimates for non-GAAP earnings stood at $0.72 per share.

CEO Greg Wasson commented on the performance in the final quarter of the year, "We had a solid quarter across our entire business. We saw improvement in our daily living business resulting from the investments we made and enhanced execution. We also saw continued strength in our pharmacy business as we increased our retail pharmacy market share for the fiscal year to 19.1 percent, and we continued to make great progress on controlling selling, general and administrative costs,"

Looking Into The Results..

Growth in revenues was driven by prescription sales which rose by 6.1%, making up 63.9% of total revenues. Growth was driven by a 6.4% comparable store sales increase in prescription sales, as Walgreen filled 203 million prescriptions during the quarter.

Other sales rose by 1.6%. Just like other retailers, Walgreen has seen a fall in traffic, which was down by 1.9% entirely offset by a 3.6% increase in the average basket size.

Gross profit margins rose by 60 basis points to 28.9% of total sales. The increase in generic drugs was behind the increase in gross margins.

Selling, general & administrative expenses fell by a full percent point to 23.9% of total sales. Lower acquisition-related costs and a benefit from litigation matters are behind the lower costs.

All in all, net earnings improved markedly, showing a 160 basis point improvement to 3.7% of total revenues.

.. And Looking Ahead

The strength in the latter part of the fourth quarter gives confidence to Walgreen's long term strategies.

The company is creating a community pharmacy fostering global and long term relationships with strategic partners Alliance Boots and AmerisourceBergen (ABC).

The synergy program with Alliance Boots delivered net synergies of $154 million in the first year, ahead of the guided $125-$150 million synergy target. Actually synergies are seen between $350 and $400 million for this fiscal year.

With regards to AmerisourceBergen, Walgreen started a 10-year strategic relationship at the start of last month to distribute branded pharmaceuticals to ABC in order to create long term value and growth. Walgreen actually bought $224 million in ABC's stock.

These collaborations, as well as Walgreen's Balance Rewards loyalty program with 85 million enrollment,gives the company the ability to customize advertisements to members in order to boost sales.

The company is furthermore a leading participant in the preferred pharmacy network of thee national Medicate part D plans, positioning the company to benefit from the growing number of Medicare-eligible participants following the Affordable Care Act.

Valuation

Walgreen ended its fiscal 2013 with $2.11 billion in cash and equivalents. The company operates with $5.05 billion in total debt, for a net debt position of close to $3 billion.

For the full year of the fiscal 2013, Walgreen generated $72.2 billion in revenues, up 0.8% on the year before. GAAP earnings came in at $2.5 billion, up 15.2% on the year before. Note that GAAP earnings per share rose by merely 5.7% to $2.56 per share.

Trading around $56 per share, the market values the equity of the firm at some $53 billion. This values Walgreen's operating assets at 0.7 times annual revenues and 20-21 times annual earnings.

Walgreen pays a quarterly dividend of $0.31 per share, for an annual dividend yield of 2.3%.

Some Historical Perspective

Walgreen has mostly been a dormant stock over the past decade. Between 2003 and 2013, shares have traded in a $25-50 trading range. Yet in 2013, shares have risen some 45% year to date, breaking out of the long term trading range, as shares almost hit the $57 mark in recent weeks.

Between 2009 and 2013, Walgreen has increased its annual revenues by a cumulative 14% to $72.2 billion. Earnings rose by roughly a quarter to $2.5 billion in the meantime. Despite the issuance of shares over the past year, the company has retired some 5% of its shares in the meantime.

Investment Thesis

So Walgreen had some pretty upbeat comments and looks with confidence towards 2014, a year in which revenues are ought to grow further. At the same time, more synergies should become visible from partnerships, boosting the prospects for the firm.

The company realizes that it is still operating in a difficult consumer environment, amidst a changing healthcare system. At the same time Walgreen has seen real momentum and progress, in its vision to be the first choice in health and day living for everyone in America, and even beyond.

The company operates some 8,582 location in the US, seeing modest growth on the year before. The company furthermore has 700 in-store convenience care clinics, and health and wellness centers, as the company is merging all of this together.

Note that Walgreen is seeing pressure on discretionary spending, on non-essential items in the front-end. At the same time strong generic sales are pushing sales earnings forward.

The agreement to acquire a 45% stake in UK Alliance Boots for $6.7 billion last year, added roughly 8 cents to adjusted earnings over the past quarter, as annual synergy estimates are ahead of schedule. Under terms of the original deal, Walgreen could acquire the entire company in two year's time.

Back in September of last year, I last took a look at Walgreen's prospects when shares were trading in their mid-thirties. I concluded that shares offered few short term triggers, but represented an excellent long term investment.

Well, shares haven't moved anymore for the remainder of 2012, but I did not expect such a large move upwards in 2013 at the time, as the current valuation has pushed up the price earnings multiple to a steep 20 times earnings.

I concluded that investors were looking forward to the future as Walgreen remains upbeat on the back of the AmerisourceBergen and Alliance Boots deal. Of course the fact the company rejoined the Express Script (ESRX) network again was helpful as well.

During the quarter, Walgreen actually introduced the Smart90 Walgreen's, a 90-day prescription program with Express Scripts, for customers to receive maintenance medication at home or in the store. Such programs should boost customer retention rates.

To be honest I am blown away by the solid returns so far this year, also driven by high hopes for the positive benefits from ObamaCare. At the same time I am more cautious now compared to last year.

I wouldn't pick up any shares at this level, given the good news already factored in at the moment, with shares trading at 20 times earnings.

Source: Walgreen - Cautious In The Short Run, Long-Term Potential Keeps Increasing