Since Walgreen (NYSE: WAG ) announced fiscal Q1 2013 earnings in late December, shareholders have enjoyed a nice little 8% spike in share price. That must have been one great quarter, right? Why else would Walgreen shares pop, while its primary competitor CVS Caremark (NYSE: CVS ) continues to outperform expectations, yet is priced, relatively speaking, the same as Walgreen?
Turns out, Walgreen has what amounts to a pass from the investment community, dating back to September when CEO Greg Wasson patched things up with Express Scripts (NASDAQ: ESRX ) . Since making up with the prescription drug provider, there's been the same, recurring theme from Walgreen proponents: "Just wait until Express Scripts kicks in!"
Beyond Express Scripts
Wasson's plans for Walgreen, as outlined in his 2013 growth strategy announced a few days back, included the usual CEO-speak. Beyond the expected salesmanship, Wasson shared some interesting tidbits that help explain Walgreen's relatively lofty valuation.
Walgreen plans to expand its food offerings in 2013, beyond basic dairy and canned goods, becoming a one-stop shop for customers on the go. On the one hand, investing in its high margin, private-brand sales -- an area that now accounts for 22% of Walgreen's brand penetration -- is a no-brainer. Walgreen's 29.4%gross profit margin last quarter was a significant improvement from the prior year's 28.1%, and with over $17 billion in quarterly sales, squeezing out another 1.3% in margins is big. Ramping up sales of its private brands certainly won't hurt Walgreen's already-improving margins .
On the other hand, adding fresh food in Walgreen stores, part of Wasson's plan in 2013, conjures up images of margin-eroding, food waste write-offs, and for what? To be all things to all people? With just shy of 64% of total revenues last quarter coming from prescription sales, it's difficult to picture the drugstore customer filling a prescription and then grabbing a head of lettuce on the way out. Time will tell if Wasson and team can change customers' perceptions. The bigger question is, do they want to?
Continued expansion in 2013 of Walgreen's mobile-friendly services isn't surprising; reaching out to an increasingly techno-savvy customer base is a necessity today, regardless of industry. What was really intriguing about Wasson's discussion of the coming year is expanding Walgreen's health and wellness services. The vision is for Walgreen to become an alternative health-care provider, offering customers Medicare wellness visits, chronic care, primary care, and additional immunizations. Walgreen is already the leading retail provider of immunizations in the country, administering over 5 million flu shots a year.
Wasson made an intriguing point when he said, "With nearly 70% of the U.S. population either without a primary care physician or not utilizing one, and more than 30 million people gaining insurance coverage in 2014 under health-care reform, we are well-positioned to fill the void in care." Walgreen's recent announcement of its new, on-site health center at BMW Manufacturing is further evidence the market for expanded health-care services is there. Now it's just a matter of capitalizing on it.
The integration of Alliance Boot, Walgreen's new (partial) acquisition, is expected to pay big dividends in 2013, in both revenue and cost-saving efficiencies. Already the biggest drugstore in the U.S., Walgreen is quickly making strides toward becoming the largest in the world. Larger isn't always better, of course, but if the integration with Alliance is handled effectively, Walgreen's overall operations could improve dramatically.
Investing in Walgreen
In spite of declines in same-store sales, earnings, and revenues, Walgreen investors are buying into what Wasson's selling; its share price is proof of that. If the CVS earnings call on Feb. 4 proves to be another outstanding quarter, as Q3 was, you can bet CEO Larry Menlo will once again thank Walgreen for CVS' performance. While Menlo boasts about retaining Walgreen's former customers, which he will, some investors may consider jumping ship to CVS, but hold that thought.
As it stands right now, both CVS and Walgreen are trading at almost identical trailing earnings ratios -- CVS is at 17.4, and Walgreen's trades at 17.7 -- though, CVS is the one coming off a record-breaking quarter. Why is that? Because when you take a look forward, the case for Walgreen starts making more sense.
With a forward P/E of 10.6, Walgreen is considerably less expensive than CVS' 13.2, and even though last quarter's earnings disappointed, Walgreen was still able to add over $500 million to its strong cash and equivalents position. And with less long-term debt than CVS, along with more cash, Walgreen more than holds its own, financially.
There's a lot riding on Walgreen's 2013 performance, and it's time to deliver. But with Express Scripts -- and soon, Alliance Boot -- fully integrated, new market expansion plans under way, and a 2.8% dividend yield, there's a strong case for Walgreen in 2013.
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