Walgreen Co (WAG) is a long term growth generating stock. Despite mixed results for 3QFY14, I reaffirm my bullish stance on the company. With its impressive sales growth in 3QFY14, the company outpaced the recent quarter's sales of its closest competitor, Rite Aid Pharmacy (NYSE:RAD). However, in the recent quarter, an increase in generic drug prices not only caused an earnings miss, but also contracted the company's margins by increasing its cost of sales. However, the synergies enjoyed by the company from its partnerships with Alliance Boots (NYSE:AB) and AmerisourceBergen (NYSE:ABC) are adding well to its bottom-line results. Also, I believe its investment initiatives and focused approach to reduce cost will generate long term growth.
WAG is the largest retail drug store chain in the U.S. The company is widely spread in the U.S with its 8,683 stores. Until recently, 19% of the U.S. retail pharmacy market share has been owned by WAG.
The company has been posting decent financial growth over the quarters, but in the recent quarter, investors were served with a mix plate of results when it came to WAG. In 3QFY14, the company continued to post decent growth in its sales base, with an increase of 5.9% year-over-year. Prescription sales are 64.4% of WAG's total sales, which increased 8.4% year-over-year in 3QFY14. As the number of aging individuals is rapidly increasing in the U.S., more people are getting enrolled under healthcare programs like Medicare and the Affordable care Act [ACA]. Due to this increase in aging individuals, WAG witnessed an increasing number of prescriptions filled in for the Medicare program patients and the increase in the Affordable Care Act enrollees, which boosted the momentum of prescriptions filled in at WAG by 11.6% year-over-year in 3QFY14.
Moreover, the company's prescription sales outpaced the recent quarter's 2.3% year-on-year script growth reported by RAD. RAD's recent quarter revenue, which increased by 2.7% year-on-year, lagged behind WAG'S revenue increase.
I believe CVS Caremark's (NYSE:CVS) recent initiative to cut tobacco sales creates an opportunity for WAG in the near term to expand its sales base by serving tobacco shoppers who no longer visit CVS for their tobacco needs. However, I believe in the changing health conscious environment, WAG will soon also need to cut down its tobacco sales in order to prove its concern for its customers' health.
WAG's earnings missed analyst estimates by $0.03 in 3QFY14 due to lower reimbursements of generic drugs and generic drug price increases. Moreover, the increased generic drug prices also increased the company's cost of sales, dragging down profit margins. The recent quarter's gross margin contracted 40basis points year-over-year. In its efforts to reduce gross margin pressure, the management has announced that soon there will be acceleration in its activities to improve the cost structure of its core business. I believe the management's commitment to lowering costs and growing profit margin will benefit its margins.
Partnerships with AB & ABC
WAG's two promising partnerships with AB and ABC have added well to the bottom-line success of the company. The combined realized synergies by the end of 3Q were $367 million. WAG is pulling well towards its idea of becoming an organization that delivers and meets the challenges of healthcare by improving service delivery and health outcomes through its partnership with AB.
There are still a number of opportunities at AB that WAG needs to work on to get full scale benefit from this strategic transaction. The second part of WAG's deal with AB is yet to be disclosed. Moreover, improved synergies from this consolidation will grow WAG's margins.
Moreover, through its partnership with ABC, WAG is jointly sourcing generic drugs and generating logistical efficiencies. The logistical efficiencies derived from this partnership have gone well for the working capital of the company. In 3QFY14, the company managed to get an improvement of 9.8% year-over-year in its working capital due to a reduction in payables and inventory level. Going forward, by combining its distribution in the U.S. and Europe with ABC, WAG will be able to increase its profitability level by saving more in costs through better negotiation power.
Strong Cash flows
WAG has been generating strong cash flows along with efficient operations. The company generated cash flows of $1 billion in 3QFY13 as compared to $1.1 billion in the same quarter the previous year. Solid cash flow generation has helped WAG continue its investments in strategic growth drivers, renovate stores through the new "Well Experience" format and open new in-store clinics. As the company also remains committed to look for new growth opportunities to better its operational performance, WAG's long term profitability will expand.
Despite WAG's recent quarter's mixed financials, I remain bullish on the stock due to its long term growth potential. In 3QFY14, WAG did experience a drag on its earnings base and observed the contraction of profitability, but the improving prescription sales and revenue base remain positive takeaways. Also, the company is expected to continue to benefit from its strategic steps, which include partnerships with AB and ABC. Due to the aforementioned factors, I believe the company will deliver healthy results in the future.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.