Buy Walgreen's to Benefit from Obama-Care

Includes: WBA, WMT
by: Glenn Rogers

Investors here in America have lots of things to worry about these days vis-à-vis what is commonly known as the Obama trade. Will Obama tax the rich into the ground? Will Obama's stimulus package work? Is Obama anti-business?

And then there's the current favourite: how can we benefit from (or survive) Obama-Care? Healthcare-related stocks have been trading up and down based on the latest rumour of how the Obama medical plan might be implemented.

I have not been immune to this speculation. Last month I wrote in the IWB that generic drug companies were worth looking at since they could potentially benefit from the expected attack on big Pharma by Congress. Large managed-care companies like WellPoint (WLP) and UnitedHealth Group (NYSE:UNH) have been moving higher since the White House has indicated that although the goal of health care reform is firm, the path to that reform is potentially fungible.

One thing that seems certain, though, we will be faced with a fairly major redo of the current healthcare system sometime this fall. The question is: Who stands to benefit?

As I was pondering all this I noticed that Walgreen (WAG), which is the largest drugstore chain in the U.S., recently raised its dividend for the 34th year in a row. In fact, it boosted it by 22%, from 11.25c a share per quarter to 13.75c (55c annually), for a 1.8% yield. Given that many S&P companies have cut or even suspended their dividends over the past 18 months, finding one that's actually going up was a real pleasure. This move will put $99.2 million in the hands of investors (figures in U.S. dollars).

As I was reading this news, I came across an article in Barron's suggesting that Walgreen's, Caremark (NYSE:CVS), and Target (NYSE:TGT) could benefit from whatever new healthcare system emerges from Congress. The reason is that these companies operate convenient low-cost walk-in clinics often staffed by nurse practitioners, midwives, and other medical professionals below the rank of M.D. These walk-in clinics are attractive for state governments in that they free up emergency rooms and hospitals and provide basic services at much lower costs than the offices of fully accredited doctors.

Readers who travel to the U.S. or live here will notice that Wal-Mart (NYSE:WMT) and Rite-Aid (NYSE:RAD) also operate similar clinics. The difference is that they only rent space to these clinics and don't actually own and operate them, so they don't derive any direct profit from them. Of course, when people come in to seek medical care they often go directly from the clinic to the store's in-house pharmacy to buy over-the-counter aids and/or have prescriptions filled. So having clinics on site has the effect of increasing revenues from the pharmaceutical side of the business. But Walgreen's benefits in the same way, plus it earns extra profits from the clinics themselves.

The reason I like Walgreen's over Caremark or Target is that it has 346 in-store clinics and more than 370 healthcare centres throughout the U.S. The store sites have treated more than 1.5 million patients since 2005. CVS Caremark is second with more than 500 in-store clinics but Target is barely in the game with only 22 clinics in Minnesota and six in Maryland. So based on scale, Walgreen's has the best footprint and of all the drugstore companies it appears to be the best run.

That said, it missed its earnings estimates for the fiscal third quarter, which ended in May. Earnings came in at 53c a share which compared to analysts' estimates of 56c and last year's 58c. However, revenue was up 8% to $16.2 billion with same-store sales increasing 2.8%. That resulted in a big increase in free cash flow, to $1.8 billion for the first three quarters of fiscal 2009. That was up $800 million from the comparable period in 2008, hence their ability to raise the dividend.

The other reason I like drugstores generally is that they don't really care if they sell generic or non-generic drugs. As the population continues to age, our need for various forms of remedies is likely to continue to increase. There will probably be upward price pressure from suppliers but big companies like Walgreen's can push back and would likely win that kind of margin battle. Certainly, as consumers continue to be challenged by the on-going recession, all retailers are suspect to some degree but the food and drugstore segments appear to be the least vulnerable.

Wal-Mart is also a great play and investors could consider having some shares in their portfolio but the stock is more expensive in absolute terms so you'll get more bang for your buck with Walgreen's. Walgreen's stock closed last Friday at $29.82, which is about in the middle of its 52-week trading range (high $37.85, low $21.28).

Action now: Buy with a price target of $32.