Ailing Walgreens Gets a Healthy Dose Of Wall Street Medicine

The past few days have been brutal for Walgreen's shareholders as the stock plummeted from close to it's 52-week high price a new 52-week low price. The first three days after Walgreens reported their 4th quarter results, more than 120 million shares changed hands with a loss of more than 15% of it's market capitalization. The culprit: reduced profit margin due to pressures from Medicare part D reimbursements and increased (payroll, operational and advertising) expenses resulting in lower than expected earnings.

With the stock lingering below the $40 mark, value buyers may be tempted to own a piece of this growth story. Walgreens has over the years shunned acquisitions in favor of organic growth and continues to open new stores across America. At the last count, they had more than 5,300 stores with another 475 new stores planned for the next fiscal year. CVS, a major competitor of Walgreens, has seen its share price appreciate even as Walgreens continues to trade within a range. Unlike Walgreens, CVS has chosen to take the mergers and acquisition route to grow its pharmacy and pharmacy benefits manager businesses. It's merger with Caremark seemed to have paid off and has the company positioned to protect it's pharmacy business from shrinking prescription re-imbursements.

Now that Walgreens is trading at it's 52-week low price, is this the right time to become a shareholder of this once respected growth story?

The answer lies in its valuation. Historically, Walgreens has always traded at 40 to 60 times its earnings. However, over the last decade, there has been a contraction in it's price-earnings ration. From the highs of 50's in the 90's and the turn of the millennium, the stock today trades at a multiple of 19. The less than double digit growth as is now evident with the chain has in-turn resulted in investors punishing the chain driving down it's earnings multiple.

Assuming that the continued store openings, the aging of the not-so-healthy baby boomers, increased generic use as more blockbusters come off-patent and the introduction of pharmacy-only category of medicines, it is safe to assume that Walgreens will grow its revenues in the coming years.

So what is the company's fair value? Is it still over-valued at $39? Without doubt, I believe the stock is oversold at this level. Assuming that they successfully grow the business as we approach an economic slowdown, they should achieve at least 5% rate. Assuming further contraction of their EPS from low 30’s to 25 it is safe to value the stock at $43. Therefore, at $39 the stock is indeed undervalued by at least 10%. Since Walgreens has always traded at a premium, my target price in the coming 12 months including a 10% premium is $47. However, the just released results makes it hard to justify such a rich premium on the company.

Currently trading at $39 and change, I have placed a limit order at the $39 mark as I missed the sale that happened last week after they reported their results. Even though, its no longer an aggressive growth play, the current price makes it an attractive value stock with a possible 10% appreciation by the end of the year. At this point, the upside outweighs the risk for this growing company that boasts no debt in it’s books.

Disclosure: none

Comments

[Winston Kotzan:]

excellent analysis

2007 Oct 13 01:13 PM

[User 147942:]

I VERY MUCH APPRECIATE THIS ANALYSIS. IT HAS PUZZLED ME WHY AN EXCELLANT,WELL RUN COMPANY SUCH AS WAS DEPRECIATING IN STOCK PRICE VALUATION. THANK YOU

2008 Feb 09 02:21 PM