Walgreen Co. (WAG) is the largest drugstore chain in the United States with more than 8,600 locations in 50 states. Walgreens reported its third quarter earnings on Tuesday June 24th for fiscal year 2014. The company reported y-o-y increases in both profit and revenue but failed to meet analysts' expectations.
Performance during the Recently-Ended Quarter
The sales of the company during the third quarter were $19.4 billion up 5.9% from the $18.3 billion in sales for the third quarter of fiscal year 2013. The increase in sales was primarily driven by the 4.8% increase in comparable store sales during the quarter. The GAAP operating income for the quarter was $1 billion, up 3.5% compared to the $991 million operating income of last year. Prescription sales accounted for 64.4% of sales during the quarter and increased by 8.4% compared to last year on the back of a 6.3% growth rate in prescription sales at comparable stores. Adjusted third-quarter earnings per diluted share increased 18.1% to 85 cents compared with the adjusted earnings per diluted share of 72 cents of last year. The GAAP earnings per diluted share increased 4.8% to 65 cents compared with 62 cents in last year's third quarter. The improvement in top-line growth was primarily driven by the increased daily living sales and strong increase in both prescriptions filled and the company's pharmacy market share. In addition, the lower-than-expected tax rate contributed a benefit of nearly 8 cents per share toward the company's bottom line.
Update on Walgreens-Alliance Boots
Back in 2012, Walgreens completed its 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 Boost contributed $0.15 per diluted share to the company's recent quarterly results and combined net synergies for the quarter totaled $131 million. In addition, the combined net synergies for the first three quarters of fiscal year 2014 were approximately $367 million. Although the company withdrew its profit and revenue forecast goals for fiscal year 2016 that were previously announced in 2012, it is expected that the combined synergies in the fourth quarter of fiscal year 2014 will be $0.67. In addition, the company increased its estimate from $375-$425 million to $400-$450 million for the year. The company will hold a meeting in July or August to make key decisions regarding the Alliance Boots deal, cost-saving initiatives and potential capital structures, and it will set new goals and metrics for 2016.
Walgreens' Partnership with ABC
Walgreens 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. However, in the recent quarter the sales of generic drugs remained stagnant, but the future prospects of generic drugs are looking bright. In the last few years, the U.S. market for medicines has shifted more towards generic drugs and it is expected that generic spending will further increase by $47 billion in 2015. By combining the company's distribution logistics in the United States and Europe with ABC, Walgreens will be able to negotiate better prices for generic and branded drugs. However, while the agreement with ABC is now in its early stage, it 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.
Walgreens' Balance Rewards Loyalty Program
Walgreens' Balance Rewards loyalty program has been playing an instrumental role in sales growth and the company's performance. By signing up, customers can receive discounts and other perks that make shopping at the company as rewarding as possible. The company's reward program reached more than 100 million enrollees and nearly 80 million active members in the recent quarter. Walgreens has the largest retail loyalty program in the industry. In addition, the company has a plan to leverage the customer insights from its reward program to further advance its value preposition and enhance customer experience.
Cost Savings Program
As part of the company's efforts to optimize its cost structure, the company has decided to close 76 unprofitable stores between April and August 2014 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.
It is expected that healthcare spending in the United States will double as a percentage of GDP by 2040. The increase in spending is basically driven by an aging population and government efforts to broaden insurance coverage. The following diagram shows the U.S. healthcare spending as a percentage of GDP.
Source: Healthcare Primer
Walgreens is a leading retail drug store chain in the United States and it will definitely receive a huge share of health cost spending in the coming years. This would boost the company's top and bottom lines.
Walgreens is a market leader in the healthcare industry. Although the company's performance in this quarter did not meet analysts' expectations and the company withdrew its profit goals for 2016, I still believe that the company is a good candidate for long-term investment. Walgreens has a strong future prospective due to its partnership with ABC, efficient cost savings program, and long-term growth in the healthcare industry. Furthermore, the company expects cost savings of $400 to $450 million this year through the Alliance Boots partnership which is $25 million more than previously anticipated. Based on all of these facts, I give the company a buy rating.
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