The stock market "word of the day" on Tuesday was defense, as in forget scoring that touchdown for now, let's try not to give too much ground with your portfolio. Whether that focus remains, it's always good to know some defensive stocks that should hold up better than most in tougher times. Walgreen Co. (WAG) might be one such stock. The steady nature of its drugstore business has underpinned this stock through turbulence before, and it did give less ground than most in Tuesday's rout.
Walgreen is the nation's leading drugstore chain, and it plans to stay in that position with a fairly aggressive course of expansion that include acquisitions. Walgreen aims to have more than 7,000 stores by 2010, up from the current number of 5,580 stores. It expects to open nearly 500 new stores this year, and it keeps gobbling up smaller chains along the way.
Drugstore stocks are conventionally thought of as classic defensive stocks, with steady profits no matter what the condition of the economy. In reality, though, the big players like Walgreen have a cyclical element to their profile, as non-pharmacy retail sales are influenced to some degree by the ups and downs of consumer spending. Profit margins on general merchandise sales such as cosmetics, food, and beverages are fatter and give a nice supplement to the steady business of prescription drugs, so this evolution has generally been embraced by the investment community.
Walgreen is not immune to the cyclical concerns about rising rates and a housing downturn choking off the economy, but prescription drugs still account for about two-thirds of sales. Don't be fooled into thinking there's no growth, though, currently pharmacy and non-pharmacy (a.k.a. front-end) sales are like twin engines. In January, pharmacy's sales were up 13.1% on a comp store year-over-year basis and front-end sales rose 6.6% for a combined 10.1% same-store performance. Total sales for all stores increased 17% to $4.53 billion, and that's just for one month.
Walgreen's stock has lagged the broader market gains slightly over the past two and five year periods, but over the past decade WAG has dramatically outperformed the S&P 500 with its 300%+ gain. Its solid stock performance is underpinned by steady profit growth in the mid-teens. The consensus is for EPS growth of 18% this fiscal year ending in August and an average of 15% over the next five years.
This company is a blend of steady, dependable growth underpinned by pharmacy sales along with a cyclical opportunity if the economy supports profitable merchandise sales. This is not a small company: Walgreen's revenues are expected to approach $54 billion this fiscal year. Usually the law of big numbers precludes big companies to make large profits and grow like Walgreen does. That law simply says that the bigger a company gets, the harder it is to post meaningful gains in any part of the business because the company is already penetrating much of the market, making it harder and harder to gain share. Walgreen has figured out a way to continue to grow, and do it profitably.
Walgreen has managed its financial resources extremely well. There is no long term debt. This gives the company plenty of borrowing power in case it wants to expedite its growth by opening more stores quicker or by acquiring another chain, but for now Walgreen says it sees no need to issue long-term debt during the next several years.
People always need drugs. That's one reason the stock carries some insurance against recession, though its increased dependence on front-end sales do give it a semi-cyclical profile these days. Nonetheless, this is a stock that has rarely disappointed and rarely has a price pull back of more than a few dollars, and its prospects for growth remain solid.
WAG 1-yr chart
Disclosure: Author has no position in WAG.