Is Walgreen Running Out of Fresh Ideas?

After a disappointing third-quarter earnings report, Walgreen (NYSE: WAG  ) is ready to double down on efforts to blur the distinction between its pharmacy business and new retail operations. In a recent interview with Fortune, CEO Greg Wasson said the opportunity for expanding front-end sales is too great to pass up, so it will offer more fresh foods to consumers.

Earlier this year the pharmacy chain said that groceries were the elixir for what ails it, and while sales have grown in the intervening months, they've been below expectations as foot traffic has continued to decline.

In its June quarterly earnings report, Walgreen said sales rose 3.2% to $18.3 billion with front-end revenues barely nudging higher at 0.4% likely due to customer traffic in comparable stores dropping sharply, or nearly 4%. It was saved only because its average basket size increased 4.4%.

Walgreen further claims it increased its pharmacy market share from 18.4% to 19.2%, suggesting the very public problems it had with Express Scripts (NASDAQ: ESRX  ) may be a thing of the past now, but that makes it a more competitive battlefield with CVS Caremark (NYSE: CVS  ) , which is also experiencing slower front-end sales, even though Walgreen fared better.

Front-of-store revenues at CVS were down 0.4%, but it blames the shift in the Easter holiday for the 65-basis-point shift. With Walgreen's fiscal third quarter ending on May 31 and CVS' fiscal second quarter ending a month later, Easter falling on March 31 could indeed be why Walgreen's sales were higher. We'll need to see how its fourth-quarter results fare to understand whether operations are truly on the mend or if it was simply the beneficiary of holiday-shifting. Since Rite-Aid's quarter also ends at the end of May and it also saw front-end sales rise 0.4% in its first fiscal quarter despite comps and pharmacy sales falling, I'm inclined to believe this may be a one-off result for Walgreen.

While I remain skeptical of the pharmacy chain's decision to go after fresh produce as a means of keeping the momentum going, it at least shows Walgreen is thinking about how to turn its business around and make it a more meaningful shopping experience for its customers.

In the Fortune interview, Wasson said he picked up a statistic showing that 60% of people don't know by 10 a.m. what they're having for dinner that night. He wants to have Walgreen be the place consumers turn to when they're making those decisions as they're running through the store to pick up their prescriptions. 

I think that's the fatal flaw in the plan. While the chain may be gaining share and it may see its pharmacy sales rising, lifted in no small part by the explosion of generic drug sales resulting from the pharmaceutical industry falling off the patent cliff, people just don't pick up prescriptions every day. There's just not enough of a public perception of Walgreen as a grocery store to make customers go there instead of Kroger, Safeway, or Wal-Mart. And since Express Scripts acquired mail-order drug service Medco, which has also implemented an auto-renewal service for prescriptions, the need to even visit a pharmacy is declining.

That explains why Walgreen needs new ideas to get people into its stores, but with the prospects that its results will wilt like day-old produce when it reports fourth-quarter earnings, I think the best prescription for investors will be to sit on the sidelines for a while.

The whole retail space, pharmacy and otherwise, is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.


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