WAG: More Green in Store for Walgreen
By TERESA RIVAS | MORE ARTICLES BY AUTHOR(S)
Walgreen's second-quarter results suggest the drug chain has the right prescription for continued success.
HAS WALGREEN (ticker: WAG) hit a wall? We don't think so.
Before Tuesday's opening bell, America's largest drugstore chain reported fiscal second-quarter results that missed estimates. The company said it earned 68 cents a share on revenue of nearly $17 billion, ahead of the year-ago period, but shy of analysts' expectations of 71 cents and $17.2 billion.
Although same-store sales fell slightly, Walgreen was optimistic about future trends, saying that new store openings would rise 4.5% to 5% in 2010, and continue to grow at a 2.5% to 3% annual rate afterward.
Despite the miss, Walgreen's stock gained 1.2% to a recent $35.75. Though it's not often that a company is rewarded for missing numerous key benchmarks in a quarter, the Street has the right idea about the stock, and we think it should climb further.
The stock trades at a cheap 13.3 times forward earnings. That's slightly ahead of its main rival CVS Caremark (CVS), which Barrons.com has recommended in the past. (See Barron's Take, "Impressed by CVS," Feb. 8, 2010.)
Still, at 1.6%, Walgreen's yield is slightly higher, and its long-term-growth rate of 14.5% just edges out CVS' 14%. So the two are nearly evenly matched, but there should be room for both to grow.
As Barron's magazine wrote in February, given Walgreen's opportunities, the shares could well rally more than 40%, to as high as $50 in the next year, given its Duane Reade acquisition and positive underlying fundamentals, including expanding margins. (See Barron's, "Walgreen Finds the Right Remedy for Tough Times," Feb. 22, 2010.)
Walgreen's latest earnings only reinforce the bullish hypothesis. Of course, it would have been better for the company to deliver a better-than-expected quarter, but that's not to say that the company isn't showing strength.
Gross margin rose to 28.8% from 28.3%, a trend that should continue as capital outlays decline. William Blair analyst Mark Miller wrote in a note earlier this month that the company is already on track to save $250 million with its Power (pharmacy and prescription) program, which has shown success in Florida and will likely be expanded to other states in the near future. Given that discretionary purchases remain depressed, such continued cost-savings should not only pad margins but also enhance results when the recovery is further along.
The company's optimism about same-store-sales growth doesn't look misplaced either. Lackluster discretionary purchases are currently an industry-wide phenomenon, and the early panic over swine flu, which boosted the fiscal first quarter, largely subsided in the second quarter. Core prescriptions and prescription sales saw growth. Redesigned test stores have been showing same-store-sales improvements, and Walgreen expects to have a full 40% of its stores refurbished before 2010 ends.
The Duane Reade acquisition should also contribute to robust same-store-sales growth. As Thomas Weisel Partners analyst Steven Halper noted, "Duane Reade currently generates the highest sales per square foot of any company in the retail drugstore industry."
That's not to say that the rest of 2010 will be easy. Earnings per share are expected to dip in the coming quarters as Walgreen integrates Duane Reade and finishes its restructuring. But earnings, revenue and profit for 2010 are on trend to grow nicely year-over-year through 2012.
So Walgreen will likely continue to deliver healthy returns for some time.
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If you take anything I say as advice, you're crazier than I am.
