Walgreen Upgraded to Outperform - Analyst Blog

Recently, we upgraded Walgreen (WAG) to Outperform with a target price of $50.00.

Walgreen's first quarter fiscal 2011 results have been encouraging despite the current economic uncertainty, which is having an impact on discretionary spending and reimbursement issues. 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.

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.

Although economic uncertainty is having a negative impact on Walgreen's sales, the company is on the lookout for suitable opportunities which would enable it to benefit once the economy is back on track. In this respect we view the acquisition of Duane Reade Holdings as a smart strategic move to help the company grow rapidly in the New York metropolitan area.

Thereafter, in September 2010, Walgreen entered into an agreement with Graymark Healthcare (GRMH) to acquire the latter's retail pharmacy business, 18 ApothecaryRx pharmacies of 5 states – Colorado, Oklahoma, Minnesota, Missouri and Illinois.

Furthermore, Walgreen divested its long-term care pharmacy business to Omnicare (OCR) in exchange of the latter's home infusion business. Moreover, sales are expected to increase further once the CCR rollout is complete in 2011. We are also encouraged by the advances it has made in the immunization market.

Through the end of the first quarter, approximately 5.6 million flu shots were administered, higher than the year-ago period which was marked by the H1N1 pandemic. The company is undertaking several steps to become a prominent player in the $40 billion total immunization market.

Moreover, with a strong cash position, Walgreen tries to benefit its shareholders by means of dividend payments and share repurchase programs. During the past twelve months, Walgreen returned more than $2.6 billion in the form of dividends and share repurchases to its shareholders.

Although the current dividend-payout ratio is 26% (for fiscal 2010), the company has set a long-term dividend payout target of 30%–35% of net earnings. In the last eight years the company's dividend has grown at a compound annual growth rate of nearly 22%.

During the quarter, the company bought back $510 million worth of stock. Stock repurchases added $0.04 to the company's earnings during the quarter. Moreover, a strong cash balance is likely to support the company in making suitable acquisitions, which should drive revenue going forward.

 
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