DRIP Portfolio Candidate: Walgreen

This week, Fool analyst Jason Moser is standing in for Todd Wenning and pitting Walgreen (NYSE: WAG  ) against Bryan Hinmon's Buffett-approved Becton, Dickinson in the Fool DRIP Portfolio's battle of health-care companies.

When my buddy Bryan asked me if I would join the DRIP team and write a piece on Walgreen, I thought, "Sure! Man that would be a lot of fun!" Then I thought, "Wait a minute, is this a setup?" Don't misinterpret my trepidation -- it's just that I've been involved in too much high jinks with that dude. But I'll take Bryan head-on and tell you why Walgreen is the right prescription for your DRIP portfolio.

Pop quiz, hotshot: You just landed in Hawaii and are in need of a prescription and some sunblock. (Yes, I've whisked you off to vacation, but you forgot your cholesterol medication; just go with it.) What are you going to do? Well, wherever you are, chances are pretty good that you can join the other 5.6 million daily customers and get what you need at one of about 7,500 Walgreen drugstores.

Walgreen has a rich history. Founded back in 1901, the Walgreen we know today has a full-on national presence in all 50 states, the District of Columbia, Guam, and Puerto Rico. And while prescriptions account for more than 65% of sales, this is no one-trick pony. Have you checked out its website lately? You can get anything from Halloween costumes to groceries and seemingly everything in between. It's no wonder its site gets more than 12 million visits per month.

Four reasons Walgreen is DRIP-o-licious

  • They're everywhere! The fact that more than 70% of the American population lives within five miles of a Walgreen store means that convenience is going to play a big part in Walgreen's success. Management intends to gain market share by adding even more stores, so they're not done yet.
  • Margin power. A substantial portion of Walgreen's business is filling prescriptions, and over the next several years many popular prescription drugs are going off-patent. That means more money for Walgreen as the generic drugs afford the company much higher margins. With an aging population (the boomers are coming!), I expect margins to expand over time. Hey, and if they pick up some more denture cleaner while they're filling their high-margin prescriptions, that's OK, too.
  • Dividend me. The point of a DRIP portfolio is to reap the benefits of solid dividend payers over time; Walgreen does not disappoint here. The company has paid a dividend for 311 straight quarters. That's more than 77 years. And what's more, it has raised its dividend for 35 consecutive years. History doesn't guarantee the future, but when a company has done something like this, it becomes a reputation thing.
  • Value? We got value! Today's price of $34 per stub implies that Walgreen needs to grow at around 4% annually over the next decade, with a 2% terminal rate and a 12% discount rate. All those assumptions appear to be quite reasonable, if not conservative. And with the stock trading at a historically low EV/EBITDA of around seven, I am confident we are getting a good deal today on a great long-term holding.

Risks to consider

  • Not above the law. Unless you forgot to refill your medications, then you know that health-care legislation has been a key issue as of late. As HMOs and pharmacy benefit managers continue their efforts to reduce prescription drug costs and pharmacy reimbursement rates, Walgreen could certainly feel the pinch.
  • The only game in town? Walgreen isn't the only player in this competitive space. You may have heard of a little company called CVS Caremark (NYSE: CVS  ) . The two companies recently settled a spat, but the two are far from friendly. A quick look at the operating statistics shows why Walgreen is my drugstore of choice.

Company

Operating Margin

ROE

Cash Conversion Cycle

Interest Coverage

Walgreen

5.1%

14.5%

33.7 days

40.7 times

CVS Caremark

6.5%

10.2%

48.8 days

12.2 times

Rite Aid (NYSE: RAD  )

0.9%

NM

51.4 days

0.4 times

Source: Capital IQ, a division of Standard & Poor's.

  • Control costs.With Walgreen building out new stores and updating old ones, SG&A costs will need to stay under control, especially in this economic climate. Last quarter, the company reported an 8.6% increase in SG&A costs from the previous year while sales increased only 6.1%.Walgreen will need to keep this in check to make future growth worthwhile.

Foolish bottom line
Now I know that Bryan is going to hit you with all he's got in convincing you that Becton, Dickinson needs to be the next Fool DRIP Portfolio winner. What's more is I know he is going to do a great job. But remember, I took you on a mental vacation. While in Hawaii, Walgreen saved the day, and it can do the same for your DRIP portfolio.

Want to discuss Walgreen or DRIP investing further? Meet us on the DRIP Investing board here on Fool.com.

Check out a complete catalog of previous Fool DRIP Portfolio articles here.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.

Stock Advisor analyst Jason Moser owns no shares of any companies mentioned. Becton, Dickinson is a Motley Fool Inside Value pick. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.


Read/Post Comments (3) | Recommend This Article (9)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 07, 2010, at 2:36 PM, Ingalls2001 wrote:

    A genuine question from a local standpoint: the Walgreen's in my area are both old stores. They are both fairly good locations, but the parking lots are small, the inside of the stores seem cramped and unwelcoming. The CVS stores have both been built in the last five years, are in "growing" areas of the city in prominent locations, have larger parking lots, more "open" store arrangements, etc...

    From my local viewpoint, Walgreen's seems to have missed the wave of current "architecture" that CVS is obviously riding. Buffet likes Harley-Davidson because of the fact that it's tough to find a brand that people are so loyal to that they tatoo it on their own bodies. SGA costs for the Walgreen's in our area are very necessary if not *needed*, and it will not be cheap. CVS already has the stores built in better locations for the next 20 years.

  • Report this Comment On October 07, 2010, at 2:41 PM, Ingalls2001 wrote:

    It would seem CVS is positioned for the future, and will draw customers more due to their accommodations already built into their stores. Walgreens has some serious and difficult ground to make up in the meantime...more due to how they built their stores 20 or more years ago.

  • Report this Comment On October 07, 2010, at 2:45 PM, Ingalls2001 wrote:

    The Buffet comment is relevant to me simply because he looks and listens. If you walk through a mall and see an empty Buckle, and a bustling Aeropostale and hear three or four groups of teenagers talking about wanting to stop by the Aeropostale store before they leave...wisdom says it is time to buy some ARO.

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