Walgreen Company: Should Investors Love This Dividend Aristocrat?

We might not have a royal family in the US, but steady income seeking investors are well acquainted with dividend aristocrats like Walgreen (NYSE: WAG  ) . Members of this elite class have steadily increased shareholder distributions during each of the last 25 years.

After more than a century of operations Walgreen continues to reach new heights. When it last reported earnings, quarterly revenue broke a company record of $19.6 billion as comparable store sales rose 4.3%.

Upwardly mobile
While growth at Walgreen has been respectable, its top line is dwarfed by CVS Caremark's  (NYSE: CVS  ) . As both the second largest pharmacy benefit manager and retail pharmacy store operator in the U.S., its fourth quarter 2013 revenues reached $32.8 billion.

Walgreen is still No. 1 when it comes to U.S. retail pharmacy sales, but just barely. CVS Caremark's retail pharmacy segment reached $17.2 billion in 2014's fourth quarter as same store sales grew 4%. The company should release first quarter earnings early next month, but until then its retail pharmacy segment appears to be a few steps behind Walgreen's.

A distant third
In terms of retail pharmacy sales Walgreen and CVS Caremark are miles ahead of their nearest competitor, Rite Aid  (NYSE: RAD  ) . Investors that prefer underdogs are enamoured with the company's recent turnaround. After years of losses it's been furiously shuttering, remodeling, and rebranding stores. So far the plan is working.

Earlier this month Rite Aid reported quarterly revenue of $6.6 billion. The company closed 37 stores throughout the year, ending fiscal 2014 with 4,587 -- a U.S. footprint roughly half of Walgreen's. Despite the reduction in locations, the top line was about $100 million higher year-over-year. The gain was driven by a same-store sales increase of 2.1%.

Payout power
Rite Aid's return to positive earnings is impressive, but the company hasn't paid a dividend since 1999. By contrast, CVS Caremark may soon deserve a seat at the dividend aristocrat table along with Walgreen. Since 2003 both companies have steadily increased their dividends at a compound annual growth rate over 20%.

WAG Payout Ratio (TTM) Chart

WAG Payout Ratio (TTM) data by YCharts

Both companies have increased dividends by a similar rate over the past 11 years, but CVS has done so without breaking a sweat. The company has stayed a step ahead of Walgreen, while distributing less than 24% of net income to shareholders.

Spreading out
Walgreen's U.S. retail operations may be just a few steps ahead of CVS Caremark's, but it's hardly in danger of losing its top spot on the worldwide retail pharmacy leaderboard. Over the past few years Walgreen has stacked the deck with some shrewd maneuvers, dealing itself a royal flush in the process.

Following a seven-month fight with Express Scripts that forced millions of customers to fill prescriptions elsewhere, Walgreen began reducing its exposure to the U.S. market. The company's 45% stake in Alliance Boots effectively makes it the world's single largest purchaser of generics. A joint venture with China's Guangzhou Pharmaceuticals could help it retain that title for years to come.

Bigger customers usually get bigger discounts. Just over a year ago Walgreen entered another partnership to consolidate its drug purchases through a single channel. Pharmaceutical distributor AmerisourceBergen is now responsible for all of Walgreen's branded drug purchases, and will soon handle all of its generics.

While Walgreen has been aggressively expanding abroad, CVS keeps control of its exposure to the U.S. retail market through the integration of a second business channel. As a pharmacy benefit manager it now serves more than 60 million plan members. Operating profit from the company's pharmacy services segment rose about 15% last year, comprising roughly 38% of the 2013 consolidated total.

Final take
CVS Caremark's consolidation of retail pharmacy, benefit management, and health clinic is a smart move for retaining customers in an increasingly austere environment, with CVS pharmacies increasingly serving as a one-stop shop for customers. The upward trend of its top and bottom lines over the past couple years suggest it's working. I'll be surprised if CVS doesn't earn a seat at the dividend aristocrat table in about 14 more years.

Walgreen's bold expansion into international markets presents an excellent opportunity for long-term growth. Unfortunately the strategy also includes a great deal of execution risk. Until this dividend aristocrat's international expansion plays out further, investors might sleep easier with CVS Caremark in their portfolios and Walgreen on their watchlist.

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