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Summary

  • Walgreen's is trading at an attractive P/E of 26x 12-month trailing earning, versus an industry average of 41x 12-month trailing.
  • Synergies from Alliance deal increased $25 million from previous estimates.
  • Tax inversion in Switzerland will help with avoiding high U.S. Corporate rates.

Overview

Walgreen (NYSE:WAG) the Deerfield, Illinois-based retail drug stores and pharmacies operator sells primarily prescription & non-prescription drugs. The stores also sell personal care, beauty care, health supplements and convenience products.

The company has also expanded into providing healthcare services like infusion therapy, intravenous medication for cancer treatments and nutritional assessment.

Walgreen is renowned for its modernized pharmacy system, which provides the pharmacist access to patient prescription records enabling seamless monitoring and timely refills. Walgreen operates 8,683 stores in all 50 states of the USA.

Earnings missed analyst estimates, but the company's performance remained solid

Walgreen released its Q3 2014 results ended in May 31, 2014 on June 24, 2014. The revenue increased 5.6% year-on-year (for 9 month period) to $57.3 billion, with Prescription sales contributing around 64% of revenue and increasing its market share to 19%. Based on the company's recent quarter revenues, it is on course to equal, or even surpass, its current trailing 12-months revenue of about $71 billion, that is if it can maintain the current run-rate.

The company faced cost pressure due to high third party reimbursements and generic drug price inflation, which decreased the gross margin by 40 basis points to 4.2% in Q3 2014. The adjusted net profit for 9 months ended May 2014 increased 7.5% to $2.17 billion. The EPS for Q3 2014 increased from $0.85 to $0.91, but missed analyst estimates by 3 cents.

Based on these figures, the picture is clear. Walgreen delivered a solid performance, bar increased costs. The company's trailing 12-month gross margin is particularly low. Nonetheless, it is still the most attractive among its closest rivals, with CVS Caremark (NYSE:CVS) and Rite Aid Corp. (NYSE:RAD) boasting 19% and 28% respectively.

A positive guidance ahead of Alliance Boots deal, all be it cautiously

The company guidance for full year 2014 is positive with an estimated EPS of $3.44. The expected synergies from the strategic joint venture (45% by Walgreen) with Alliance Boots for 2014 is expected to increase by a further $25 million from previous estimates.

The planned acquisition (from existing 45% to 100%) of Alliance Boots is expected to be delayed as Walgreen needs to sort out issues related to transaction structure and timing. Therefore, the company's initial target of reporting consolidated revenue by 2016 may not be realistic for now.

Nonetheless, the deal is expected to close by August 2014. The acquisition also paves way for Walgreen to domicile operations in Switzerland. This could turn the deal into a 'tax-inversion' deal and consequently, Walgreen's would be able to avoid high taxation in the US. However, these developments are not clear, and this has been the cause of volatility in the stock, which fell 2.1% last week.

Valuation still looks attractive

The stock had an extended bull run throughout 2013 gaining 50% from $36 to $56 and the rally continued further in 2014 to reach 52-week high of $76.39 following excellent results in Q1 and Q2 of fiscal 2014.

The prospect of synergies from acquisition of Alliance Boots could also have played a part in the company's rally. The stock is currently trading at about $74 per share, which equates to a P/E multiple of 26x its trailing twelve months EPS. This is particularly attractive compared to the industry average of 41x, which means the company has some room to run, if investor sentiments change in its favor.

However, the recent delay in finalizing Alliance-Boots acquisition has created mixed sentiments. This could pull the P/E multiple down to low 20s as the stock retreats to reflect investor views. Nevertheless, even at a P/E multiple of 23x, the price target based on 2014 EPS estimate is $79, about 7% upside from current price.

If Walgreen can achieve cost efficiencies and meet estimated EPS levels, a maximum upside of $90 is possible in the next 6 months.

Furthermore, the possible completion of a tax inversion deal could provide tax savings and further increase EPS estimates.

The bottom line is that any temporary pullback could prove to be an attractive buy opportunity, as the stock seeks to re-establish rally.

Source: Walgreen's Post-Earnings Pullback A Buying Opportunity