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We recommend buying Walgreen (WAG) ahead of its Q3 12 earnings release on September 28 for a short-term speculative trade. Our bullish call is based on a combined assessment of what we believe to be useful predictive factors for earnings surprises and post-earnings stock price movements. These factors span key variables across valuation, analyst estimate trends and technical strength.

Valuation (undervalued)

We believe Walgreen to be undervalued both on an absolute and relative basis. On an absolute basis, Walgreen's 2013 P/E based on consensus analyst estimates currently stands at 11.5x, which we believe to be below fair value, given its projected 2013 EPS growth of 20%, and expanding gross and EBIT margins over the past 3 years. On a relative basis when compared to its publicly traded comparables, Walgreen is valued at a discount to Wal-Mart (WMT) and CVS (CVS), on both 2013 P/E and EV/Revenue, despite much faster expected EPS growth in 2013.

A summary comparables analysis is presented below to highlight key valuation multiples, growth, and profitability metrics between Walgreen and its comparables:

Valuation Multiples

Market
Cap

Enterprise
Value

P/2013
EPS

P/2012
EPS

EV/2013
Revenue

EV/2012
Revenue

WAG

30,621

31,021

11.5x

13.8x

0.4x

0.4x

WMT

250,320

297,650

13.9x

15.1x

0.6x

0.6x

CVS

61,049

68,629

12.7x

14.3x

0.5x

0.6x

RAD

1,130

7,196

N.M.

N.M.

0.3x

0.3x

Growth

Revenue
Growth

EPS
Growth

FY13

FY12

FY11

FY10

FY13

FY12

WAG

3%

-1%

7%

6%

20%

-2%

WMT

5%

6%

6%

3%

9%

10%

CVS

4%

15%

12%

-2%

12%

20%

RAD

0%

-3%

4%

-2%

-93%

-67%

Profitability

Gross
Margin

EBIT
Margin

FY11

FY10

FY09

FY11

FY10

FY09

WAG

28.4%

28.1%

27.8%

6.0%

5.1%

5.1%

WMT

25.0%

25.3%

25.5%

5.9%

6.1%

5.9%

CVS

19.2%

21.1%

20.7%

5.9%

6.4%

6.5%

RAD

26.0%

26.5%

26.6%

1.0%

0.9%

0.9%

Source: Company filings, Yahoo Finance

Analyst Estimate Trends (neutral)

Current Analyst Estimates

Revenue estimates for Walgreen's current quarter range from $17.61bn to $16.67bn, with an average estimate of $17.14bn (-4.6% from $17.97bn in Q3 11), while EPS estimates range from $0.51 to $0.62, with an average estimate of $0.56 in EPS (-2% vs. $0.57 in Q3 11).

Walgreen has met or slightly exceeded EPS estimates in three of the past four quarters. Recent analyst EPS estimate revisions are neutral, with Q3 12 EPS being revised down from $0.58 (90 days ago) to $0.56 (current).

EPS Surprise History (neutral)

Q2 12

Q1 12

Q4 11

Q3 11

EPS Estimate

0.62

0.77

0.67

0.55

EPS Actual

0.63

0.78

0.63

0.57

% Surprise

2%

1%

-6%

4%

EPS Estimate Revisions (neutral)

FY14

FY13

Q4 12

Q3 12

Current

3.09

2.58

0.67

0.56

7 Days Ago

3.07

2.59

0.67

0.57

30 Days Ago

3.05

2.59

0.67

0.56

60 Days Ago

3.00

2.59

0.67

0.56

90 Days Ago

2.93

2.61

2.66

0.58

Source: Yahoo Finance

Technical Strength (bullish)

We believe Walgreen's underlying technical strength, as measured by its historical share price performance, to be bullish, with its Moving Averages and MACD technical indicators all under bullish signals.

Moving Averages

· 20-Day Moving Average: Bullish

· 50-Day Moving Average: Bullish

· 100-Day Moving Average: Bullish

MACD

· 20-50 Day MACD Oscillator: Bullish

· 20-100 Day MACD Oscillator: Bullish

· 50-100 Day MACD Oscillator: Bullish

Earnings Speculator is a trading advisory service designed to capture alpha by predicting post-earnings moves of stocks through a detailed analysis of key predictive factors. While our goal is to generate consistent alpha over time through employing a long-term positive probability edge in our predictions, the ultimate performance of any one of our individual stock recommendations is highly uncertain. We strongly recommend allocating no more than 2% of your trading portfolio to each of our recommendations in order to sufficiently diversify your risk and to be well positioned for long-term alpha generation through focusing on the prediction of post-earnings share price movements.

Source: Buy Walgreen Ahead Of Q3 12 Earnings