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

Investors in Walgreen (NYSE:WAG) had a terrific 2013 as the stock performed really well on the back of the major deals. In the final week before the end of the year, the company released its first quarter results for the fiscal year of 2014 which continues to show solid growth.

Given the strong earnings outlook for operations in 2016, following the full acquisition of Alliance Boots, shares still offer appeal to long term investors. Given the limited short term appeal, I remain cautious however for now.

First Quarter Results

Walgreen generated first quarter revenues of $18.33 billion, up 5.9% on the year before. Revenues comfortably beat consensus estimates at $17.98 billion.

Reported GAAP earnings rose sharply by some 68.3% to $695 million. GAAP earnings per share advanced from $0.43 on a diluted basis last year to $0.72 per share in the past quarter. Earnings were in line with expectations of analysts.

Adjusted earnings came in at $688 million, up 24.1% compared to a year ago. There were some big items affecting GAAP earnings. A positive impact was the $0.17 per share impact of fair value adjustment to the purchase of AmerisourceBergen's stock, largely offset by acquisition-related charges, taxes etc.

CEO Greg Wasson commented on the developments over the past three months, "Given the continued soft economy, we were generally satisfied with our top-line growth where we increased both traffic and sales for the quarter as well as our pharmacy market share. However, the year-over-year negative impact related to generics, including the significant shift in the generic wave from a peak a year ago to a trough this quarter as well as our strategic decision to make meaningful promotional investments in our daily living business, affected our margins for the quarter."

Looking Into The Results..

Reported sales growth of 5.9% was mostly driven by comparable store sales which were up by 5.4% on the year before. Traffic was up just 0.2% while the basket size rose by 2.2%. The remainder is driven by higher pricing.

Notably prescription sales, which make up 65% of total sales rose by 7.3%. The company filled 213 million prescriptions in the quarter, up 5.8% on the year before, marking another quarter of market share gains.

Gross margins took a serious beating, falling by 130 basis points to 28.1% of total revenues. Fewer generic drug introductions and higher promotions impacted margins.

Despite this margin pressure, Walgreen managed to reduce the actual amount of selling, general and administrative expenses. Those costs fell by 150 basis points to 23.9% of total revenues. Equity earnings in Alliance Boots amounted to $151 million compared to just $4 million a year earlier.

Valuation

Walgreen ended the quarter with $969 million in cash and equivalents. Total debt stands at $5.07 billion, resulting in a net debt position of $4.10 billion.

Full year revenues for the fiscal year of 2013 came in at $72.22 billion, up 0.8% on the year before. Reported earnings were up by 15.2% to $2.45 billion.

Trading around $57.50 per share, the market values Walgreen at $54.5 billion. This values equity in the firm at 0.75 times annual revenues and 22 times GAAP earnings.

Walgreen's quarterly dividend of $0.315 per share, provides investors with an annual dividend yield of 2.2%.

Some Historical Perspective

Long term investors in Walgreen have seen very strong returns, driven by the excellent performance in 2013. Between 2004 and 2012, Walgreen's shares traded in a $25-$50 trading range.

Shares ended 2012 around $37 per share, and have risen some 55% ever since to current levels at $57 per share. In previous weeks, shares set all-time highs of $61 per share.

Between 2010 and 2013, Walgreen managed to increase its annual revenues by a cumulative 7% to $72.2 billion. Reported earnings were up by 17% to $2.45 billion as Walgreen managed to slightly reduce the share count, despite the Boots deal last year.

Investment Thesis

Walgreen had a solid quarter, with reported revenue growth being strong. According to IMS Health, the research firm for the industry, the firm boosted its market share in the retail prescription market by 50 basis points to 19.4%. Revenue growth was also driven by a stronger flu season despite the slow start. Some 6.4 million flu shots have been administered so far this season, up 1.1 million compared to a year before.

Gross profits were impacted however, mainly on the back of fewer generic drug introductions. Yet this pressure will diminish later this year.

Of course, the main focus for the medium term future is the acquisition of the 45% stake in Alliance Boots in 2012 in a $6.7 billion deal. Under terms of the deal, the company can buy the remaining stake in the UK-based business in two year's time. As a result of the partnership, the company sees full year synergies of $350-$400 million for the fiscal year of 2014.

Following an integration of Boots, Walgreen is targeting revenues of $130 billion in 2016. Operating income is seen around $8.5-$9.0 billion which could easily support a net debt position of $11 billion. Factoring in normal interest rates and taxes, and GAAP earnings could come in between $5 and $6 billion. On top of this is obviously the strategic partnership with AmerisourceBergen (NYSE:ABC), as both parties have committed to a strong partnership for the coming decade.

At the start of October, I last took a look at Walgreen's prospects following the release of its fourth quarter results. Shares traded at similar levels as today. At the time I concluded that the deals with Alliance Boots and AmerisourceBergen create more long term potential. The strong guidance following the consolidation of Alliance Boots in the coming two or three years, makes the current valuation justifiable with GAAP earnings expected to double in three year's time.

I remain optimistic about the long term prospects but are in no hurry to pick up shares after the stellar momentum, which in my eye limits potential for the immediate short time.

Source: Walgreen - Long Term Appeal Remains After Runway 2013 Momentum