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Walgreen (NYSE:WAG) disappointed the market with misses in revenues and gross margins. It claims to fill one in five prescriptions, which gives it dominant national market share. (Regional variances may be significant.) It has digested Duane Reade and is buying up its own stock in the marketplace. This, as we know, engineers higher EPS all in the guise of returning capital to shareholders.

Check out the balance sheet. Walgreen is an operating business. The old school concepts of working capital and liquidity are very important. Walgreen's long-term debt is almost equal to its cash position. The working capital seems adequate until you understand just how big the long-term debt is. But Q2 stock purchases of $890 million seem ultra high to the long term debt of $2.4 billion. You cannot sustain this pace of stock repurchase. The value investor would have been more impressed with large reductions in debt.

Another item to consider is interest rates. Long-term debt may be locked in but will eventually increase in costs. 2% on 2.4 billion will clean out another $50 million or so of shareholder wealth... so the investors who are supposedly rewarded today through share buybacks are leaving an increasing debt legacy for investors who chose to stick around.

And that is why when revenues and margins miss street expectations, the stock sells off precipitously. Walgreen’s management does not have street credibility.

Disclosure: I hold no positions in stocks mentioned in this post. I have no plans to initiate new positions within the next 72 hours.

Source: Walgreen on the Wrong Track