Walgreen: Attractive Valuation and Growth Story 18 comments
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I purchased shares of Walgreen Co. (WAG) because it screens well in my factor model and it looks even better after a detailed review.
Some key metrics from my factor model include attractive margins (WAG has better gross (28.28%) and operating (5.84%) margins than their industry (25.25 and 3.51, respectively), and they beat major competitors (CVS and Rite Aid) in most categories. Price/Earnings ratio (17.54) is better than CVS, Rite Aid, and the industry. Walgreens had a positive earnings surprise in 3 of the last 4 quarters, and earnings has increased every year for the last five (14% annual growth rate). Price/Earnings/Growth (PEG) ratio is 1.17, which is very attractive for a company with an aggressive growth schedule like Walgreens. Also, WAG has low debt and extra cash on their balance sheet that will be used to fuel growth (no share buybacks planned).
A detailed review of WAG reveals a strategy dedicated to growth. Management is committed to 8% annual store growth in 2008 (550 new stores, net increase of 475 stores), and expects 600 new stores in 2009. Management thinks the US can support 13,000 Walgreens stores (at 8% they won't reach this number this decade, which means years of projected growth).
Management is also committed to adding more high value products and services such as DHL services, ink cartridge refills, and others. Walgreens also intends to extend pharmacy offerings. WAG is in the specialty pharmacy market which is growing at 20% per year, versus traditional retail pharmacy which is only growing at 8% per year.
Overall, Walgreens has an attractive valuation and an attractive growth story.
Disclosure: Long WAG
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This article has 18 comments:
In my past, I have been a loyal Walgreen customer and one day it dawned on me that it doesn't make sense to pay for Walgreen's 24-hour convenience if I am paying prices that are 30% to 50% higher for the identical products, respectively, that are being sold in Wal-Mart. Now, I have access to a 24-hour Wal-Mart super store and there even less of a need to shop at Walgreen. That said, I hold the opinion Walgreen's margins will not stay at lofty levels.
Let's not forget the two main drivers of valuation creation are "margins" and "capital base" (per Tom Copeland et al) and my point is the high margins won't be there. Selling products like high-price ink cartridge refills does not reflect reality and opening more stores that are not competitive in the marketplace is sheer folly.
As I go down Mr. Munger's mental checklist, I keep asking myself the basic question of: "What is the compelling reason for customers to shop at Walgreen versus WalMart?" By the way, I noticed your Walgreen comps listed failed to capture WalMart -- perhaps that was an omission on your part to make Walgreen look attractive?! Hmmm.
Cheers.
Thanks for your comments, and I appreciate your perspective. I also think you are incorrect to believe Walgreens needs compete with WalMart on cost.
The compelling reason for customers to shop at Walgreens versus WalMart is convenience. It takes about three minutes to park your car, walk into a Walgreens, find what you want, pay for it, and be back in your car again. At WalMart, it takes three minutes to find a parking spot, four minutes to walk to the front door, ten minutes to find what you want, ten minutes to pay for it… you get the point.
Also, Walgreens has much more convenient locations that the typical WalMart.
Walgreens is able to charge higher prices because they provide convenience. That’s just Michael Porter 101.
Mkreisel – great point on international markets.
I'm sorry but your argument goes from bad to worse. Let's take your ink cartridge refills as a example of high value products that will add value to WAG. If the argument is on convenience, as Mr. Hines asserts, then buying these ink cartridges refills online if far more convenient and is also congruent with Porter's thesis (please ask yourself, why did companies such as HP and Dell have software that monitor ink-levels along with automatic reminders, perhaps to create captive markets? Hmmm).
WAG may charge, in my opinion, a small premium for convenience, but that convenience is not economic moat by any stretch of the imagination. I have a HP inkjet printer and despite the nice software reminders, I still buy them from Costco or Walmart because I am a creature of habit.
Cheers.
Thanks again for your comments, and your point on ink cartridges is well-taken. However, I still think the convenience argument stands. When time is critical people aren’t going to wait 3 to 5 business days for an Internet delivery when they can pick it up at Walgreen’s in 5 minutes. It's like buying Coke out of a vending machine; why do people pay $1.25 when they can get it from the grocery store for 25 cents. Convenience.
I also go there to get my film developed, since CVS uses the Kodak machine, and I hate it.
Also, the druggists at Walgreens are really nice, and seem to remember me well, though I only see them once a month.
Now, I could go to Walmart, but since I'm not watching every penny I spend, it's just not worth it to drive the 6 or so miles to Walmart, and spend tons of time parking, finding stuff, waiting forever to have my prescription filled, and then waitng in line to pay. It's great for many people, but Walgreens, CVS, and others definately have their niche. And it's probably with people who read financial news and not People magazine.
About the ink comment-The author has a point. I don't know where you live, but one of fastest growing and successful franchises recently is Cartridge World. What they do could be done in a walgreens and it makes sense.
Speaking of convenience ? so you mail off you cartridges How do they get refilled online? Good bit cheaper just replacing ink and not the whole hardware. Not to mention environmental concerns with disposing of cartridges - specifically toner .
Walgreens have premium locations. That is their strategy and competitive advantage.
Hard-pressed to find another company that is so meticulous on store location. WAG loves stores on a busy ass street - (highly visible) AND corners /backs up to residential- (very accessible).
WAG has proven for years people will pay a premium for convenience especially if they already are going to the pharmacy.
COST, WMT etc, those stores are all great, but where I live, and where maybe some of you do to, those stores are outside the city, in swarms of traffic, and parking lot so big u need GPS. Thus, it's not everyday that some one living in a city goes to COST or WMT. It be cool if I did though.
I wrote this back in Oct, and I a working on an update.
Take a look if it interests you.
financial-alchemist.bl...
They also sound a loud alarm as you enter if they don't like your looks.
These practices have been keeping coustomers from shopping at their stores
I also don't see Wal Mart taking much business from any of the drug stores. The two closest Wal Marts in my area I can think of several Wallgreen, CVS, and even Right Aid stores I would pass before I got to the Wal Mart. Since I, like most Americans, have health insurance, I'm much rather go to the closer drug store than drive all the way out to Wal Mart. But perhaps Wal Mart is expanding prescription drugs to people who previously couldn't afford them and didn't have insurance, but that's not taking any share from the drug stores.
First good luck on your CFA designation, it's a tough program. I was awarded my CFA designation in 2001 when the exams were easier. I made a mistake of pursuing my MBA at Stern and the CFA designation at the same time; it was just too hard to do both at once.
Second about the ink refills when you wrote: "Speaking of convenience ? so you mail off you cartridges How do they get refilled online?" The manufacturers such as HP want as much of a closed-loop as possible. The software alerts the user to order new cartridges (via online) before s/he runs out akin to EOQ or JIT theories and these new cartridges come in the mail so s/he won't have to make time critical convenience purchase. At the same same, you send back the used cartridges in the mail back to HP so HP can recycle the cartridges.
Third is the continuity assumption -- just because WAG was successful in the pass doesn't mean it will continue to do so in the future. You are making a huge assumption that WAG will continue its own ways and may be dangerous. In the old days, downtown department stores (with premium locations) had real economic power and then when the malls was developed, these same downtown stores became dinosaurs.
Good luck.
I understand that because you are long WAG, it may affect your ability to understand opposing viewpoints. I still believe you haven't made a case for convenience at WAG and instead you have argued why one shouldn't invest in WAG from an ROIC perspective.
You have argued that consumers will choose WAG out of convenience over WMT based on your comment of: “[i]t takes about three minutes to park your car, walk into a Walgreens, find what you want, pay for it, and be back in your car again.” Then you strengthened this argument with your comment of: [i]t's like buying Coke out of a vending machine; why do people pay $1.25 when they can get it from the grocery store for 25 cents.”
Any investor who understands ROIC could see the holes in your argument. First, your argument implies that WAG doesn’t get a lot of business because the parking lot is empty and that there are few customers in the store all because of the 3-minute turnaround time from car to store and back to car that you have asserted. In contrast, WMT has a lot of business because it’s parking lot is crowded (hard to find a parking spot since it takes 3 minutes), lots of consumers are shopping in WMT (10 minutes to pay for something), etc. This begs the question why a company like WAG would spend so much money to build (or rent) a big box, spend the money on inventory, face slow inventory turns, etc, etc, just for the random convenience shopper who pay a small price premium? In contrast, WMT’s big box makes economic sense since the parking lot is full, consumers are buying cartloads of products, etc (please note the sales velocity along with high inventory turns, etc), respectively. In this sense, WAG is wasting economic resources and is destroying value by using a broken business model.
Now, let’s address the Coke vending machine analogy. From a ROIC perspective, it makes perfect sense to use vending machines (low economic cost base) to sell a random Coke products than to spend the money for a big box, the inventory, etc (see previous paragraph). The high mark-up helps offset the uneven demand for the Coke product (and we know demand is uneven because the buyer is random because he is looking for convenience at time of purchase).
Mr. Hines, I don't believe I can convince you so you can have the last word if you choose. I've enjoyed our friendly "debate" and I wish you much success on your WAG investment.
Cheers.
I see what you are saying about the refilling online, I know all about it. I have 2 all-in-one inkjets. The indication pops up, and takes right to the ordering site. I never used it though. It really started to piss me off because, if the black was empty, or the color was empty it wouldn't let you print at all, and would send you to buy ink.
I couldn;t even print BW when color was low. On my older one it lets you print BW and when BW is empty you can print BW with the color cartridge even though it;s a waste. I hated be held hostage like that because the $$$ is all in the ink and that;s why the printers are so cheap, they make it back on recurring purchases of ink, which only last a a couple hundred pages.
I recommend, and what I did was buy laser printers. I have the 1320 BW and the 2840 color. The toner lasts about 5000 pages. Not holding me hostage.
Now that I rambled off topic, to proceed- WAG won't change peoples habits that buy online, but for those that go to cartridge world or similar places, they are the customers WAG will pick up if that add refilling. There at least 3 cartridge worlds (I know of) in Metro Memphis with plans to add up to five more , and there are at least 50 WAG stores. I don't think one can assume everyone buys or will buy ink online. In short, convenience means something different for everyone.
On the extrapolating WAG's past into the future, I don't think WAG will be able to duplicate its past performance. It's a good company and it's not going anywhere, but margins and growth will probably decline somewhat.
About premium locations- WAG relocates so many stores each year it's crazy. I am aware that areas change and traffic migrates, just as downtowns were center, then became ghost towns, and recently have resurged, especially in Memphis. So it's in constant flux.
Just recently WAG bought a church two blocks away from a location in a strip center. Location has been there I know at least 40 years and is premo premo.
Everyone is baffled why they are building two blocks away, I conjecture its so a big box like WMT cityscape store or Kroger, TGT pharmacy store doesn't move in. Get it before a competitor does, and the existing location is in a strip so it;s tough to modify the space.
WAG does a good job keeping up with community growth and decline and moving accordingly. I don;t expect great things, but it's a stalwart bluechip and should be bought when valuation is compelling.
Thanks for your kind comments. Congrats on your CFA designation. At least they have upped the offering dates twice a year for Level 1, I sure wish they held level 3 more than once a year.
Thanks for the friendly debate. Would love to have more of your comments showing up on our Vestopia website at:
vestopia.com/Blogs/Mar...
I agree that WAG does not need to directly compete with WMT, but it should also recognize that there is a need to be creative and have more to offer.
There is a story about a small drug store that made its fortune by being creative. It sold very cheap tuna fish by the can and put it by the back register/pharmacy. There was always a long line at the pharmacy and everyone that came in thought it to be the pace to buy their prescriptions. So it grew and grew. The truth was that it was all about merchandising and not cost.
WAG needs to think about that story and realize that they are not just a more convenient clone of WMT (which they are not) Same with investors.... WAG is a convenience store, one of the last corner pharmacies (loosely)...
WAG could be a good growth story in the absence of political weight killing phara prices and ridiculous FDA oversight that is killing the entire extended industry. I still wonder with all of this, what WAG has up its sleeve to compete and profit.
Rambling....Sorry
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