Pharmacy chain Walgreen (WAG) reported mediocre fourth quarter results Friday morning. Revenues shrank 5% year-over-year to $17.1 billion, slightly worse than the consensus expected. Earnings also declined, falling 4.5% to an adjusted total of $0.63 per share, which was slightly better than consensus expectations.
Though same-store sales only slipped 1.3% during the quarter, the other 3.7% of the decline in Walgreen's sales came from consumers switching to generic drugs from branded drugs. Prescription sales, due to the feud with Express Scripts (ESRX), were the major contributor of weakness, falling 8.1% year-over-year. Some of the downward velocity in prescription sales should moderate now that the two firms have come to an agreement, but we think the company will struggle to regain market share it lost to competitors like CVS (CVS). Though the company finally developed a loyalty card program, we've noticed pricing at Walgreen tends to be at a slight premium to CVS, which could help explain why comparable store traffic was down 3.2% during the quarter. As we've seen play out at Supervalu (SVU), pricing has been driving traffic, so non-value pricing simply doesn't work anywhere (but on the high end). To read how our Valuentum Dividend Cushion warned investors of SuperValu's impending cut, please click here.
The company remains optimistic about its decision to purchase British pharmacy Alliance Boots, though we're not really big fans of the deal. We think it's distracting that Walgreen is focused on acquiring more growth instead of shoring up its core business, which is far from firing on all cylinders. Management continues to tout cost savings and synergies as a result of the deal, but they seem to be missing the big picture. The firm has taken on a substantial amount of debt to pay its dividend and acquire the stake in Alliance Boots, while profitability is clearly declining. The firm laid out targets for fiscal year 2016 that include $130 billion in revenue and operating cash flow of $8 billion. The cash flow forecast seems unrealistic, in our view, as the firm will likely need to sacrifice profitability to reacquire angry Express Scripts consumers.
Although the quarter wasn't that great, we still believe shares of the firm are fairly valued. To read how we calculate the intrinsic value of Walgreen via an extensive DCF process, please click here. We think the firm can raise its dividend, though we'd like its dividend growth potential even more if it hadn't acquired this stake in Alliance Boots. However, we see several metrics, including profitability and traffic declining, so we fear Walgreen's could struggle in the near- to intermediate-term. As a result, we won't be adding shares to the portfolio of our Dividend Growth Newsletter (please see links in our left sidebar for more information).