Mixed 2Q for Walgreen Co. - Analyst Blog


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Walgreen Co. ( WAG ) reported earnings of 78 cents per share in the second quarter of fiscal 2012, beating the Zacks Consensus Estimate by a penny. However, reported earnings were a couple of cents lower than the year-ago earnings.

Reported result includes a positive impact of one extra day of operation due to leap year compared with the year - ago quarter. The company incurred a negative impact of 3 cent per share related to the mild cough/cold and flu season in the quarter and 7 cents related to Walgreen's non-renewal of the Express Scripts ( ESRX ) contract. As per the decision, effective January 1, 2012, Walgreen is no longer a part of Express Scripts' pharmacy provider network.

The year-ago quarter result included a negative impact of a penny in integration costs related to the company's Duane Reade acquisition, which was closed in April 2010, and a penny in restructuring and restructuring-related costs associated with the company's Rewiring for Growth initiative.

The company reported total sales of $18.7 billion in the reported quarter, marginally in line with the Zacks Consensus Estimate and hurt by the termination of Express Scripts contract. Total sales edged up 0.8% from $18.5 billion reported in the year-ago quarter. Front-end comparable store sales (those open for more than a year) during the quarter climbed 2.1%. Customer traffic in comparable stores inched up 0.7% and basket size increased 1.4%.

Prescription sales, accounting for 61% of sales in the quarter, declined 1.7%, while prescription sales in comparable stores were down 3.9%. Moreover, during the quarter, Walgreens filed 196 million prescriptions (down 4.2% year over year) while prescriptions filed at comparable stores dropped 4.9%.

The lower incidence of cough, cold and flu led to a decline in the number of flu shots administered to 5.5 million for the season-till-date compared with 6.2 million a year ago.

Gross profit in the quarter increased 1.2% year over year to $65 million leading to a 10 basis points (bps) expansion in gross margin to 29.0%. Front-end margins were aided by convenience/fresh food, household and personal care categories. However, during the quarter, retail pharmacy margins declined due to reduction in reimbursement rates combined with specialty pharmacy mix and a higher LIFO provision, partially offset by the positive impact of generic drug sales.

Walgreens expects an improvement in gross profit in the second half of the fiscal 2012 arising from new generic drug introductions, including generic Lipitor, compared with the first half. During the reported quarter, the LIFO provision stood at $72 million compared with $56 million a year ago.

Selling, general and administrative (SG&A) expenses increased 4% year over year to $167 million, including a 0.8% upside in operating and integration costs in drugstore.com, which was acquired in June last year. Operating margin during the quarter contracted 60 bps to 5.9%.

At the end of the quarter, Walgreens had $1.08 billion in cash and cash equivalents, compared with $2.2 billion at the end of February 2010. Year-to-date, the company's net cash provided by operating activities were $1.8 million. Moreover, during the quarter, the company returned $570 million to shareholders through share repurchases and dividend payments compared with $462 million in the year-ago quarter.

Earlier, in February, specialty pharmacy services provider, BioScrip Inc. ( BIOS ) and Walgreen entered into a definitive agreement, under which the former will dispense certain community specialty pharmacies and mail service pharmacy business assets to Walgreens for $225 million.

Walgreens anticipates the transaction to have no material impact on its earnings in fiscal 2012. However, the transaction will be moderately accretive in fiscal 2013.

With the intention of retaining some of Express Scripts' clients, Walgreens recently came up with its comprehensive Patient Transition Plan, which will enable the smooth transition of existing members of the Express Scripts pharmacy network to another community pharmacy. Under this plan, Walgreen is providing several discounts to the members of Walgreens Prescriptions Savings Club, which facilitates savings on over 8,000 brand names and all generic drugs.

Meanwhile, Walgreen is expanding its business with other payers and customers and implementing cost-control initiatives. The company is reassured by the fact that more than 100 of Express Scripts clients, encompassing health plans and employers, would continue with Walgreen pharmacies in 2012.

Our Recommendation

Despite its best efforts to counter the loss of the Express Scripts contract, which accounted for 7.3% of total sales in fiscal 2011, Walgreen's financials will, nevertheless, be affected by the loss of the contract.

On a long-term horizon, we are optimistic about Walgreens. The introduction of new generics should help improve the company's gross margins in the second half of fiscal 2012. Moreover, a strong cash balance enables the company to reward its shareholders.

Currently, Walgreen retains a Zacks #3 Rank (short-term Hold rating). We have a 'Neutral' recommendation on the stock over the long term.

BIOSCRIP INC ( BIOS ): Free Stock Analysis Report
EXPRESS SCRIPTS ( ESRX ): Free Stock Analysis Report
WALGREEN CO ( WAG ): Free Stock Analysis Report
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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