Why Walgreen Should Be A Core Long-Term Holding For Investors

| About: Walgreens Boots (WBA)

Walgreen Company, (WAG), which is a leading drugstore chain in the United States and increasingly abroad, offers tremendous value to long term value and income investors. The price of Walgreen's shares were hampered early in 2012 by a lack of an agreement with major prescription fulfillment partner Express Scripts (NASDAQ:ESRX). However, shares recovered sharply in July due to an agreement that has the company continuing to partner with the company.

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2012 has seen Walgreen make a major international acquisition with the purchase of Boot's, which is an English chain of drugstores. Walgreen recently announced that the company has priced a massive debt offering, borrowing $4 billion for exceptionally low rates (just 4.4% on the longest-dated tranche, due 2042). Although the large debt issuance increases the debt on Walgreen's books dramatically (two-fold), the extremely attractive rates the company secured are testimony to the company's financial strength and future prospects. The proceeds of the issuance will be used for general corporate purposes and for recent acquisitions, principally the Boots acquisition.

Walgreen has a tremendous competitive position in the United States. The company has a strong portfolio of over 8,000 stores in the United States. The retail market in the United States is competitive and dynamic, though consolidation in the drugstore space has left only two viable competitors, Walgreen and CVS (NYSE:CVS). Walgreen is facing challenges and opportunities related to cross-channel competition in retail, where merchants compete across product lines. For instance, Walgreen and other drugstores have dramatically expanded their offerings in the grocery and snack aisles, which places them in competition with convenience stores and grocery stores for these items. Similarly, supermarkets and megastores have increased their retail pharmacies and health products offerings, which offer direct competition to drugstores. This cross-channel competition will benefit Walgreen in the long run due to the role of expanded drugstores in crowded metropolitan markets. Because the footprint of Walgreen is relatively small, they become akin to small grocery stores in crowded metropolitan markets such as New York City (which they bolstered in 2010 with the purchase of local chain Duane Reade in a $1.1 billion transaction) and San Francisco. In neighborhoods underserved by grocery stores such as San Francisco's Russian Hill, throngs of grocery shoppers in Walgreen often stretch throughout the store.

Future growth for Walgreen will come domestically from increasing store density in urban areas (either through organic expansion and acquisition, such as their July 2012 acquisition of USA Drug) as well as expanding internationally. Although Walgreen still has sizeable expansion potential in the United States, Walgreen's global expansion strategy, which is best represented by their purchase of Boots noted above, is an encouraging indication that management is making investments for long-term growth. As economies across the world continue to industrialize and grow, there will be sharply increased demand for pharmaceuticals and health care expenditures.

Walgreen is tremendously attractive from a fundamental perspective. The company trades at a price-earnings ratio of just 12 at the current price of $35.36 despite strong earnings growth prospects, particularly in light of international growth and the continuation of Express Scripts business. Although the lack of an agreement with Express Scripts hampered profits and revenue during the early part of 2012, this portion of the business is ramping back up and should be fully restored within two reporting quarters. Due to Express Scripts, Walgreen's revenue is expected to be essentially flat for the current fiscal year 2012 (FY) while FY 2013 revenue is expected to be 5% higher at $74 billion. Because of the general predictability of the business, investors should expect organic (excluding acquisitions) profit and revenue growth in the range of 5-10%, which will fuel consistent dividend increases for Walgreen.

Walgreen pays an attractive dividend rate of 3.1% and has a rich tradition of dividend increases that have rewarded investors. Walgreen's dividend has grown from $.14 in 2000 to $1.10 in 2012. Walgreen has a number of characteristics that make it a cornerstone position for long term investors. Walgreen's strong competitive position in a non-cyclical retail segment, strong dividend growth, recent aggressiveness in growing the business domestically and internationally, and strong positioning both in terms of urban development in the U.S. market and through global consumer growth all make Walgreen attractive to long term investors.

Although the buying opportunity that appeared during the Express Scripts negotiation has passed, the company has continued to see negative effects from the absence of Express Scripts related revenue during their financial reporting. Therefore, investors should seek to purchase shares in the next few months (by late December 2012 when WAG will report FY 2013 Q1) before revenue and profit in reported financial statements includes a full quarter of revenue related to the continuation of the Express Scripts relationship.

Disclosure: I am long WAG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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