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Summary

  • Company looks to continue growing, as analysts project 14.8% per annum growth rate for the next five years.
  • Outperforming expectations on synergies from acquisitions remain key to bright future.
  • Decent 2% dividend yield being backed by healthy cash flows.

Walgreen Co. (NYSE:WAG) is one of three major retail drug store chains in the U.S. The company has been successfully fighting competition from key players in the drug store industry. For 2QFY'14, WAG reported a 5.1% YoY increase in net sales, driven by advertisement spending and higher drug prices. However, higher advertisement spending, coupled with a less severe flu season narrowed gross margins by 4.2% YoY in 2QFY'14. The company has been making efforts to improve its cost structure, and lowering its SG&A to support its bottom line growth. SG&A dropped by approximately 1% YoY in 2QFY'14. Moreover, the company is well-positioned among its peers, and is a decent investment choice for dividend-seeking investors, with a 2% dividend yield well-supported by its solid cash flow base. I maintain my bullish thesis on WAG, as the company's long-term growth outlook remains promising, with scaled-up estimates of synergies and operating income growth expected from the closure of underperforming stores. Analysts are anticipating a robust next five-year growth rate of 14.8% per annum for WAG.

Financial Performance
WAG reported $19.6 billion in net sales for 2QFY14, up 5.1% from the same quarter last year. Sales for the company were positively affected by higher prices. On average, health costs increased by 1.1% YoY in February earlier this year. Comparable store sales contributed 4.3% toward the total 5.1% YoY increase in WAG's net sales in 2QFY14. Meanwhile, the increasing trend of utilizing generic drugs has made prescription sales the major contributor toward overall comparable sales of the company. The following table shows the YoY change in comparable store sales:

2Q13

2Q14

Prescription Comparable Store Sales

(2.7%)

5.8%

Front-End Comparable Store Sales

(2.6%)

2%

Total Comparable Store Sales

(2.6%)

4.3%

Source: Company's Quarterly Earnings Report

A less severe flu season and a highly competitive market resulted in margin contraction for the company. WAG reported an adjusted EPS of $0.91, missing consensus estimates of $0.93, down 5.2% YoY. However, I believe the company is well-positioned to achieve long-term earnings growth resulting from top line growth and realizing return from long-term investments. The following chart shows gross and net profit margins comparison between 2QFY'13 and 2QFY'14.

Source: Company's Quarterly Earnings Report

Stock Price Drivers

The company has been effectively putting in efforts to improving its cost structure and improving margins in the competitive industry environment. As we move forward, the company's efforts to improve cost structure will also portend well for the company's margins. Despite the gross and net margin drop in the recent quarter, the company's operating margin remained flat, at 6.5%. The following table shows the SG&A and operating profit margin for WAG.

2QFY13

2QFY14

SG&A (as % of sales)

24%

23%

Operating Margins

6.5%

6.5%

Source: Calculations and Company's Quarterly Earnings Report

The company has maintained that it will yield higher-than-expected synergies from its two main strategic acquisitions of Alliance Boots (NYSE:AB) and AmerisourceBergen (NYSE:ABC). In 2QFY14, the $0.08 of adjusted EPS accretion, contributed by strategic partnership with AB, indicates WAG's strategic acquisitions being on the right track to yielding positives for the company. Moreover, the company believes in AB's growth prospects, as it expects the partnership will yield $0.13-$0.14 of adjusted EPS accretion in 3QFY14. The company is expected to realize synergies of $375-$425 million in FY'14; every $100 million of realized synergies are likely to result in a $0.05 increase in EPS. The company realized synergies of $107 million and $127 million in 1QFY'14 and 2QFY'14, respectively, which were better than estimated average synergies of $100 million per quarter. The company's ability to deliver better-than-expected synergies in recent quarters will portend well for earnings and the stock price. Moreover, WAG's underlining margins will also improve as the two successful acquisitions continue to deliver strong synergies.

Investor-Friendly Side

The company has been delivering healthy financial performance, and remains a decent investment option for dividend-seeking investors, as the stock offers a solid dividend yield of 2%. The dividend yield of 2% positions WAG well among key players in the drug store chain industry. Moreover, WAG's dividend base has the strong backing of its healthy cash flows. The company recently announced a quarterly dividend of 31.5 cents per share, representing an increase of 14.5% YoY. The following table shows the comparison of WAG's dividend yield with its peers.

Company

Dividend Yield

WAG

2%

CVS Caremark (NYSE:CVS)

1.50%

Rite Aid (NYSE:RAD)

-

Source: Yahoo Finance

The following chart shows that dividends offered by the company are backed by its solid cash flows.

Source: Company's Quarterly Earnings Report

Conclusion

I remain bullish on WAG. The company has been delivering satisfactory financial performance in the recent past, and remains on track to experiencing robust earnings growth. Analysts are anticipating a robust growth rate of 14.8% per annum for the next five years. Moreover, the better-than-expected synergies continue to strengthen WAG's brighter outlook in the coming years. Also, the company offers a solid dividend yield of 2% and generates healthy cash flows. Due to all the aforementioned factors, I believe investing in WAG means that long-term growth prospects are added to a portfolio.

Source: Walgreen: Stock Ready To Reward Investors