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Summary

  • Walgreens recent earnings release follows an approximately 3.3% increase in the stock market.
  • The company’s expectations about combined net synergies from Alliance Boots have increased.
  • The long-term agreement of Walgreens with AmerisourceBergen (ABC) would provide benefits of nearly $400 billion over a decade..
  • The pharmaceutical industry is also expected to grow and provide long-term growth to Walgreens.

Walgreen Corp (NYSE:WAG) is the largest drugstore chain in the United States with approximately 8,600 locations in 50 states. Walgreens reported its 2nd-quarter earnings on Tuesday March 25th for fiscal year 2014 and follows a nearly 3.3% increase in the stock market.

Recent Quarter Performance

The sales of the company during the 2nd quarter were $19.6 billion up 5.1% from the sales of the second quarter in fiscal year 2013 that were $18.6 billion and marginally higher than analysts' estimates of $19.5 billion. The increase in sales was primarily driven by the 4.3% increase in comparable store sales during the quarter. The GAAP operating income for the quarter was $1.3 billion up 4.9% compared to the $1.2 billion operating income of last year. Prescription sales accounted for 62.2% of sales during the quarter and increased by 7% compared to the prior year on the back of a 5.8% growth rate in prescription sales at comparable stores. The company's revenues were quite strong but earnings per share came in below expectations at $0.91 down 5.2% from EPS of the same quarter last year and also below analysts' estimates of $0.93. The decrease in earnings was caused by a number of factors such as a harsh winter that had a negative effect on customer traffic, slower generic drug introduction, a less severe flu season, and aggressive promotions.

Expectations from Synergies have Increased.

August 2012 Walgreens completed an initial 45% investment in Alliance Boots, the largest European pharmacy-led drug retailer, with an aim to create a global pharmacy by expanding its operation in new markets including Europe, China, and Latin America. Alliance Boots contributed $0.08 per diluted share to the company's recent quarter results and combined net synergies for the quarter totaled $129 million. In addition, the combined net synergies for the first half of 2014 were approximately $236 million. Furthermore it is expected that the combined synergies in the third quarter of 2014 will be $0.13 to $0.14 and the company increased its estimate from $350-$400 million to $375-$425 million for the year.

In addition, the company signed its 10-year agreement with AmerisourceBergen (NYSE:ABC) last year to jointly source generic drugs and generate logistical efficiencies. ABC provides drug distribution and related services designed to reduce costs and improve purchasing power with drug manufacturers. By combining the company's distribution in the United States and Europe with ABC Walgreens will be able to negotiate better prices for generic and branded drugs. I believe that the agreement with ABC is now in its early stage and will definitely boost the company's top and bottom lines in the coming years because it is expected that the agreement should provide a benefit of $400 billion over a decade.

Restructuring Program for Cost Savings

As part of the company's efforts to optimize their cost structure the company has decided to close their 76 unprofitable stores in the next four to five months to save $40 to $50 million per year beginning fiscal year 2015. The reasons behind this decision was the fact that most of the stores are located near other Walgreens locations, the impact of real estate positioning within the market, and material changes to a store's trade areas. In addition, the company still has a plan to open 55 to 75 new locations in fiscal year 2014 to optimize their footprint and make sure that the company's stores remain in the best locations in America.

Industry Outlooks

The demand of prescription drugs in the U.S. is expected to increase in the coming years because the U.S. has an aging population and the elderly contribute to a larger proportion of expenditure on drugs. The following diagram shows the U.S. per capita spending on healthcare compared to other developed countries. The spending of the U.S. is approximately twice compared to other developed countries.

(click to enlarge)

Source: Healthcare Primer

Medical spending will increased rapidly with age because the elderly are much more likely to be among the top spending percentiles. The following diagram segregates health costs per person on a yearly basis based on age.

(click to enlarge)

Source: Healthcare Primer

The present situation of aging can be problematic for the United States but it would provide long-term growth for the company. Walgreens is a leading drug retail stores chain in the U.S. and it will definitely get a huge share of health cost spending in the coming years. This would boost the company's top and bottom lines.

Conclusion

Walgreens is a market leader in the healthcare industry with consistently growing dividends. In addition, the company performed well in the recent quarter and also has a strong future prospective due to its combined synergies, partnership with ABC, and efficient restructuring program that will definitely boost the company's top and bottom lines in coming years. Furthermore in fiscal year 2016 the company expects to generate more than $130 billion in revenues, an operating cash flow of $8 billion, and combined synergies from Alliance Boots of $1 billion. Based on the above discussion I give the company a strong buy rating.

Source: Walgreen: A Long-Term Buy