Walgreen Tops, Profit Cruises - Analyst Blog

Leading U.S. drug retailer Walgreen Company (WAG) reported first-quarter fiscal 2011 (ended November 30) earnings of 62 cents per share, comfortably beating the Zacks Consensus Estimate of 54 cents while exceeding the year-ago earnings of 49 cents. The year-ago quarter's results include 3 cents per share in restructuring charges associated with the company's “Rewiring for Growth” initiative.

Net income for the quarter leapt 18.8% year over year to $580 million riding on higher sales and improved pricing. The company's shares were up $3.08 (or 8.36%) to $39.91 in pre-market trading.

Revenues

Revenues rose 6% year over year to $17.3 billion, mostly in-line with the Zacks Consensus Estimate. Comparable store sales (those open for more than a year) increased 0.8% while sales of front-end comparable drugstores edged up 0.4%.

Prescription sales, which represented roughly 66% of revenues in the quarter, rose 5.3% year over year. Walgreen expanded its retail pharmacy market share by 40 basis points to 19.7% from the year-ago quarter. The company opened/acquired 121 new drugstores in the quarter versus 172 a year-ago.

Margins & Expenses

Gross margin improved to 28.5% from 27.7% a year-ago, supported by improved promotions and pricing. Pharmacy margin increased modestly, favored by generic drug sales. Operating margin increased to 5.4% from 4.9% a year-ago on account of higher gross margin.

Selling general and administrative expenses climbed 7% year over year, attributable to the Duane Reade acquisition-related costs and new store openings. Walgreen remains on track to achieve its goal of $1 billion in savings in fiscal 2011 under its restructuring initiative.

Financial Condition

Walgreen generated $1.2 billion in operating cash flows during the quarter. The company exited the quarter with cash and cash equivalents of roughly $2.1 billion, down 19% year over year. Total debt increased modestly year over year to $2.4 billion. Walgreen repurchased shares worth $510 million during the quarter under its existing buyback authorization.

Our Recommendation

Illinois-based Walgreen is the largest drugstore chain in the U.S., running 7,651 stores. Apart from selling prescription drugs, it also markets over-the-counter (“OTC”) medications, general merchandise, cosmetics, toiletries, household items, and food and beverages. The company competes with other drugstore retailers such as CVS Caremark Corp. (CVS) and Rite Aid (RAD) as well as major mass merchants such as Wal-Mart (WMT) and Target Corp. (TGT).

To enhance customer experience, Walgreen has adopted a strategy of customer-centric retailing (“CCR”). This refers to enhancing store formats, pricing, promotions, and vendor relationships to provide a better experience for the customer. During fiscal 2010 (ended August 31), Walgreen has converted or opened more than 1,500 stores to its CCR format and now has more than 1,800 stores. By the end of calendar year 2010, the company plans to have over 2,000 CCR stores.

Walgreen remains committed to provide flu shots to more customers during this season and has also boosted advertising to meet the goal. The company plans to administer 15 million flu shots this season compared to 7 million last year. During this flue season, through November 30, the company had administered 5.6 million shots at pharmacies and clinics, modestly up year over year.

We are encouraged by Walgreen's progress with respect to the CCR rollout and its advances made for meeting the targeted savings under the rewiring initiative. Moreover, the company remains committed to reward its shareholders leveraging a healthy cash position and is well equipped to pursue suitable acquisitions in future.

However, the current economic scenario continues to be our major concern. Additional challenges remain in the form of reimbursement issues and slower introduction of generics. We are currently Neutral on the stock, which is supported by a short-term Zacks #3 Rank (Hold).

 
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