Several Reasons Why Walgreen Looks Appealing

Stop paying attention to all those headlines stating that Walgreen will close 76 underperforming locations. While this is true, it’s not the whole story.

Apr 5, 2014 at 9:30AM

Walgreen (NASDAQ:WBA) plans on closing 76 under-performing locations by August. That's a rapid pace, and it has led to some investors debating whether or not this is a negative sign for the company. The short answer to that question is no. 

While many recent headlines for Walgreen are centered around the store closures, they don't tell the full story. The company's net store count is set to increase by between 55 and 75 throughout the remainder of this year. Therefore, closing 76 underperforming locations simply relates to cost-cutting measures in order to improve profitability. And it's not as though Walgreen has been struggling. For instance....

Recent results
Walgreen's second-quarter net earnings of $754 million weren't as impressive as the year-ago quarter when it delivered $756 million in net earnings. To some, this was a concern. However, Walgreen's net sales increased 5.1% year over year to $19.6 billion (in-line with expectations), and comps improved 4.3%.

Comps pertain to same-store sales. They're also arguably the most important metric in retail because they exclude new store openings. New store openings lead to increased revenue growth, which then has the potential to throw investors off.

By looking at comps, you have an opportunity you see if demand truly remains strong, which often stems from customer loyalty and strategically placed locations. If Walgreen is closing underperforming locations, then it shouldn't just lead to cost-cutting but improved comps performance as well. Investors get excited when they see improving comps numbers, which then drives the stock price higher.

Comps comparisons
Walgreen has clearly delivered strong comps, especially in a hesitant-consumer environment. Additionally, its revenue and net income have increased about 4% and 27.2% over the past year.

Comparatively, CVS Caremark (NYSE:CVS) delivered fourth-quarter comps of 4%, primarily related to prescription values. Revenue grew at a 2.5% clip over the past year -- solid for the current consumer environment but not as strong as Walgreen. Net income increased 9.4% thanks to more generic drugs being dispensed and the growth of the Maintenance Choice Program. While CVS has consistently delivered stock appreciation for its investors over the past several years, it has slightly underperformed Walgreen on Main Street.

Additionally, CVS will halt the sale of tobacco products in October, which is expected to lead to the loss of approximately $2 billion in sales. Those with a strong moral compass will applaud this move, but it's not going to get cigarette smokers to stop smoking. They will simply go elsewhere, and Walgreen is likely to benefit since CVS and Walgreen stores are often within close proximity to one another.

Rite Aid (NYSE:RAD) has outperformed both Walgreen and CVS over the past three years regarding stock appreciation: 518.3% versus 79.3% for Walgreen and 131% for CVS. However, over the past year, it has lagged on the top line, delivering growth of just 0.7%. The excitement for Rite Aid has been driven by bottom-line improvements. Net income has skyrocketed 34.5% over the past year.

Rite Aid is remodeling many of its locations into Wellness Stores, altering the company's image and potentially giving it some differentiation when compared to Walgreen and CVS. Consumers can now visit Rite Aid Wellness Centers for a variety of health reasons, including immunizations, diabetes screenings, medication management and therapy services, and more.

Rite Aid has remodeled 800 locations into Wellness Centers, and it plans on adding 400 more this year. While this brand transformation leads to improved potential for the company, revenue growth hasn't been particularly impressive over the past year and has lagged peers. Fortunately, February comps grew 2.4% year over year, which is impressive.

The Foolish bottom line
Rite Aid might still be in the midst of a turnaround, but it's still not growing as quickly as its peers, and there are still no guarantees that the turnaround will be a long-term success. CVS has been a consistent winner, but it hasn't grown as quickly as its peers on the top or bottom lines, and it will stop selling tobacco in October, which could lead to a large sales decline. 

Walgreen, on the other hand, continues to deliver on all fronts: top line, bottom line, and comps. And contrary to what some investors believe, it's actually increasing its store count this year. This is often the sign of a company that's confident in its future prospects. The closing of underperforming locations should lead to effective cost-cutting as well as improved comps performance in the future. Please do your own research prior to making any investment decisions.

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Dan Moskowitz has no position in any stocks mentioned. The Motley Fool recommends CVS Caremark. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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