Walgreen Just Lowered the Boom

When companies forecast lower sales or profits, their stocks usually take a hit. It's not always easy to tell whether it's having a fire sale or burning down. Maybe it is time to get out -- or maybe it's time to buy more!

Last week, pharmacy giant Walgreen (NYSE: WAG  ) released dismal August sales numbers showing a 4.5% decline from last year as prescriptions, pharmacy sales, and comps all were in decline. Following steep drops in June and July, it's not surprising its quarterly results were coming in below analyst expectations, which had already been diminished because of the spat with Express Scripts (Nasdaq: ESRX  ) . Patching things up couldn't have come soon enough for Walgreen, and it will start filling Express Scripts prescriptions again this Saturday.

Now, don't go blindly selling into the bearish report -- you still need to do some research. Use the announcement as a jumping-off point for additional research.

Walgreen snapshot

Market Cap $30.1 billion
Revenues, TTM $72.5 billion
1-Year Stock Return 1.2%
Return on Investment 13.1%
Estimated 5-Year EPS Growth 12.0%
Dividend and Yield $1.10/3.1%
Recent Price $35.11
CAPS Rating (out of 5) ***

Source: FinViz.com.

Street brawler
Despite all the bravado Walgreen could muster, the barroom brawl with pharmacy-benefits manager Express Scripts left the pharmacist bruised and battered. After trying to extract a premium from the PBM for filling its prescriptions, Express Scripts gave Walgreen a big roundhouse punch, severing their agreement and taking its customers to CVS Caremark (NYSE: CVS  ) and Rite-Aid (NYSE: RAD  ) . And just to make sure Walgreen was completely humiliated, it bought MedcoHealth, another big Walgreen client.

Thumbing its nose at Express Scripts turned out to not be such a good idea. The benefits manager accounted for 12.6% of prescriptions filled in August of last year. With almost two-thirds of total sales represented by pharmacy sales, the loss of customers was painful indeed. Walgreen estimates that almost 11% of lost sales were due to Express Scripts' departure.

Everybody, group hug!
But that was then, and this is now. Walgreen made amends and wooed the PBM back into the fold, though the terms of the reconciliation were not released. It just needs to hope that customers who left to have their prescriptions filled at competitors will now return to its stores. Customer acquisition costs are always higher than keeping customers, so when you lose some, it's not always easy to get them back, and CVS says it expects it will keep at least half of those it gained from the split.

Then there's the big, expensive acquisition it made when it was casting about how it was going to make up for the lost customers. While the purchase of USA Drug makes some sense, less coherent was Walgreen's $6.7 billion purchase price for a 45% stake in Alliance Boots, a European drugstore chain. With all the financial unrest facing the continent, analysts don't expect the acquisition to go down without some indigestion.

It's a free-for-all
The key, of course, to Walgreen's future is how many customers return to the fold. Some analysts think only 10% of those who left will come back, which could have the pharmacist still left bleeding on the floor.

Worse, it's likely if Walgreen does regain the lion's share of customers, it won't measurably improve the situation. The reason the fight arose in the first place was because Walgreen said Express Scripts' demands wouldn't allow it to cover its costs, while the PBM said the pharmacy's conditions would have made it the most expensive of its customers. Considering the decimation caused to Walgreen's business, it's not unreasonable to think it had to meet Express Scripts more than halfway (if not all the way), so if its complaints were true, every customer it wins back will eat into performance.

And to add further insult to injury, the Defense Department's Tricare health plan announced that it will continue to exclude Walgreen from coverage, meaning another 17% of its prescriptions filled in 2011 are lost. It's also noteworthy that it comes as Wal-Mart (NYSE: WMT  ) is pushing to expand its health-care offerings to gain greater share in the space. Pharmacy services and over-the-counter drugs accounted for 11% of its $264 billion in U.S. sales last year.

As a result, it's hard to recommend Walgreen's stock at these levels, achieved after the Express Scripts announcement. There are simply too many unknowns at the moment for an investor to make a considered decision.

At 11 times earnings estimates, it's valued similarly to CVS, which doesn't have nearly the same uncertainty surrounding it. I'm rating Walgreen to underperform the broad market indexes until some dust settles, but tell me in the comments box below if you agree all this chaos gives you a headache.

Looking under rocks
For all the foregoing reasons, I think investors should sit on their hands here. Walgreen is just a big question mark. Instead, I invite you discover three winning stocks with solid dividend payouts in this free report from The Motley Fool. Get instant access to this free report, while it's still available.

Fool contributor Rich Duprey holds no position in any company mentioned. Check out his holdings and a short bio. The Motley Fool owns shares of Express Scripts Holding. Motley Fool newsletter services have recommended buying shares of Express Scripts Holding. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.


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  • Report this Comment On September 13, 2012, at 10:52 AM, Mirshaan wrote:

    Perhaps they are suddenly realizing that their decision to no longer accept Express Scripts wasn't the smartest move. They cost themselves millions in business by deciding to not take one of the most used prescription insurance in the country. Dumb business move had negative consequences?? Go figure...

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