Major drugstore chain Walgreen (NYSE: WAG ) posted encouraging second quarter results that sent its shares up from slightly over $64 each to more than $68 each after the release, although the shares gave up some of their gains in the following trading days. The report also provided some insight into Walgreen's strategy for 2014, as well as some information about the drugstore's competitive position.
Adding and shutting down stores
While the announcement that Walgreen will shut down 76 of its stores got some attention, the drugstore actually plans to keep growing its physical footprint. The announcement simply shows that Walgreen plans to add stores in locations that have better potential; subtracting the number of stores that will shut down from the projected net store count results in the conclusion that Walgreen will actually open up 131-151 new stores this year, including the ones it has already opened up in fiscal 2014.
If these stores bring in more sales on average than the old stores which will shut down, which seems likely, Walgreen could see a bigger bump to its top line than the net store addition figure implies. Walgreen came up with a store remodeling concept called "Well Experience" which included more space for frozen food and a redesigned pharmacy section, and it applied this to some of its stores in 2012 and 2013.
Walgreen's announcement shows that drugstores still have some room to add more physical stores, but shutting down underperforming locations makes sense too. Both CVS (NYSE: CVS ) and Rite Aid (NYSE: RAD ) could come out ahead here. In its last quarter, CVS added 60 new drugstores and shut down some of its other locations, and it also said that it moved 17 more stores. It looks like CVS has also found better places to put its pharmacies; watch for an update in this area when CVS reports its fiscal first-quarter 2014 results. Meanwhile, the February 2014 update from Rite Aid showed that the drugstore chain had closed 36 of its stores over the past year.
Medicare Part D
The Medicare Part D results from Walgreen's second-quarter report show that this drugstore may have gotten some revenge on CVS. Last year, CVS had boasted about the patients it took from Walgreen after the Express Scripts dispute. This year, it looks like Walgreen has taken some of CVS' Medicare Part D patients. Back in February, CVS said its pharmacy network claims dropped 0.3% for the quarter because it lost Medicare Part D patients; now Walgreen has reported a 16% gain in Medicare Part D prescriptions filled for the quarter.
CVS explained that it lost claims because it faced Medicare sanctions last year, so Rite Aid may also have benefited from the sanctions placed on CVS. The sanctions on CVS ended late last year, but they still delivered a $1.3 billion hit to the drugstore's top line.
Higher sales on lower store traffic
Walgreen reported a decline of 1.4% in store traffic but both its front-end and its pharmacy comps still showed increases of 2% and 5.8% for the quarter, respectively. This indicates that Walgreen still maintained some of its pricing power even though it took a hit of 1.3 percentage points to its gross margin. The drugstore also faced some temporary challenges this quarter. Like other retailers, management complained about the harsh winter weather. Walgreen also received a smaller boost from generic drugs than it had received in the year-ago period, although it predicted gains in this area later in the year.
The projected boost from generic drug sales probably holds the most importance for Walgreen, as well as its peers. This release indicates that the drugstores will see more bottom-line gains later on in 2014 as more drug patents expire; therefore, this growth driver remains intact and CVS and Rite Aid could see boosts to their income because of this in upcoming quarters as well. Walgreen's ability to translate lower traffic into higher comps suggests that the drugstores have retained enough of their pricing power to benefit from the superior profit margins provided by generic drugs. Walgreen's deal with AmerisourceBergen and Rite Aid's deal with McKesson could also provide advantages in regard to generic drugs.
The second-quarter release shows several growth catalysts for Walgreen. The new stores could help the drugstore improve its sales. Walgreen has also captured Medicare D market share and if it can keep it the drugstore could gain a long-term growth driver. Walgreen could also see more income from generic drugs if its prediction comes true. The headwinds appear temporary, and this drugstore looks like it's prepared for more growth ahead.
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