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Is Walgreen’s Hitting the Skids?

October 09, 2007 | About:

Mike Rubsam

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Walgreen (WAG, $39.3) stock recently sold off on below-expectation fourth quarter earnings. While earnings came in 7 cents per share below consensus, the stock sold off $7, then tailed even lower in subsequent days. The question is, is the growth story over at Walgreen’s, or is this a small bump in the road?

Walgreen’s is poised to benefit from demographic factors in their favor for the next 10-20 years, in my opinion. As the baby boomers approach retirement age, their need for prescriptions and health-related items will rise. While one can play these demographics by buying a company like Johnson & Johnson, evaluating any pharmaceutical company is difficult. In my view the national insurers like Wellpoint or United Healthcare are risky if a national health plan ever gets going. Therefore I liken Walgreen to a pure play on growing health care volumes, without the added stress and issues common to investing in pharmaceutical, health insurance, or medical product companies.

I describe Walgreen’s stores as part 7-11, part Target, and part pharmacy. Though stores like Wal-Mart and Target offer pharmacies, the convenience of Walgreen’s stores is what sets them apart. Parking is easier, the stores are smaller, less crowded, and easier to navigate, and there are more locations within the tight quarters of urban areas.

Walgreen’s intends to grow to 7,000 stores by 2010, about 20% more than they have currently. If they can grow their store base while not cannibalizing their existing stores, WAG should easily achieve 30-35% more total sales within 3 years. This would put sales at $65-70B around 2010 and earnings approaching $3/share. The company currently fills 17% of prescription orders in the U.S.

The question may arise, why pay 13X 2010 earnings when I can pay 13X next year’s earnings for Wal-Mart. Since WMT is expanding their generic program, and is cheaper than WAG, it is a good question.

For me, the answer is that because of its entrenched neighborhood locations, Walgreen’s stores will benefit disproportionately from baby boomers’ requiring more visits to the pharmacy. 28% of the U.S. population is between 44 and 62, and even though they could conceivably save a few bucks driving to a Wal-Mart, this often requires a longer drive and much more overall effort. I think it is conceivable that WAG grows at 10% rates for 20 years in the U.S. , but I don’t see those growth rates to be possible for WMT.

I recently visited Chicago and spent a few days driving around the northern suburbs. There is literally a WAG store spaced every few minutes apart. In these dense areas, Wal-Mart has no penetration whatsoever due to store size and difficult new store development conditions. WAG’s entrenched locations are a big advantage in urban areas because each neighborhood store has a small moat of its own.

I saw nothing in Walgreen’s fourth quarter earnings that alarmed me as a long term investor. They had increased labor and marketing costs, and suffered tough comparisons in their generic business, but overall sales trends looked pretty good to me. In my view it was a typical Wall Street overreaction, which I used to add to my position.

_______________________
Mike Rubsam is President of Liberty Steward Capital, LLC (www.libertystewardcapital.com), and is long shares of WAG.

About the author:

Mike Rubsam
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Comments

armeetofo
Armeetofo - 7 years ago
WAG. CVS and WMT are great companies at a good buy as i posted before.
Dr. Paul Price
Dr. Paul Price premium member - 7 years ago
I like all three [WAG, CVS, and WMT] but WAG and WMT look especially cheap on their recent pullbacks.
commodity
Commodity - 7 years ago
Never been so cheap.

CVS is a threat.
Dr. Paul Price
Dr. Paul Price premium member - 7 years ago
CVS has been a threat for many years now.
Dr. Paul Price
Dr. Paul Price premium member - 7 years ago
I sold WAG 2009 and 2010 puts at strike prices of $40 & $45.
calstar92101
Calstar92101 - 7 years ago
I agree with the article...even though some of the stores will be canabilizing profits of each other...there should be enough stores that there will be true profits in the coming yrs....wag is no dummy and I am sure that they are correcting the problem that they had and within a yr...anybody who bought at these levels should be richly rewarded...and even though wag got into the emergency-or health clinic later than cvs...at least wag is now expanding it and there should be plenty of profit potential for anyone getting into this new field now!
mrubsam
Mrubsam - 6 years ago
As a side note...

My 4 year old just came down with influenza type A. (She's fine). Of course, I got her Tamiflu at WAG. Talking with the pharmacist, he said there was a big flu outbreak pretty much everywhere.

Could be a good short term catalyst for WAG. The Medcos and Express Scripts of the world can't do much in this area. IMHO.
jdg
Jdg - 6 years ago
Walgreen has done a great job at setting itself up in the most convenient locations. Most customers, in my opinion will choose a location based on this convenience.

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