Believe it or not, Walgreen Company (NYSE: WAG ) might soon be relocating to Europe, a surprise to no one who follows the company. Don't worry, you'll still be able to shop at your friendly neighborhood Walgreen location. The company is NOT packing up and leaving the United States physically. Like so many other company's out there today the move has to do with where the company is domiciled and the tax rate a company has to pay there. The tax implications of this move are great, but will it be good for the stock and peers CVS Caremark Corporation (NYSE: CVS ) and Rite Aid Corporation (NYSE: RAD ) ?
Why move to Europe?
In 2012 Walgreen purchased a 45% stake in the United Kingdom's largest pharmacy Alliance Boots for $6.7 billion . In early 2015, Walgreen is expected to merge with Alliance Boots by acquiring the remaining 55% stake for a $16.2 billion total .
Walgreen shares have doubled since 2012 in part because of its growth but also due to the prospects of incorporating Alliance Boots. Alliance generated $36 billion of revenue and $1.3 billion in net profit last year, growth of 4.3% and 31%, respectively .
If Walgreen chooses to relocate to the UK its corporate tax rate would lower to 21% from 35% in the U.S. Hence, this 14% differential in taxes has been estimated to save Walgreen several hundred millions of dollars annually in its existing business, which translates to higher margins and more profits.
4 billion reasons
With that said, a new report from The New York Post shows that Walgreen might make a move for Switzerland, which carries a corporate tax rate of just 17.9%. This would save the pharmacy giant an estimated $4 billion over a five-year period following the Alliance Boots merger.
If accurate, Walgreen could save $800 million a year by relocating, would still have its current $2.73 billion in net income, and Alliance Boots's $1.3 billion in profit. The sum of these three inputs yields a profit of $4.8 billion which means Walgreen would trade at just 14.8 times earnings with annual revenue growth of 4%.
Given all these huge pluses, it's rather easy to see why shares have doubled since 2012 and why investors like the prospects of Walgreen merging with Alliance Boots.
This is not without controversy
Walgreen has been a U.S. company for 113 years and it's uncertain as to how consumers will feel about purchasing drugs from a foreign company - albeit one that is foreign from just a legal standpoint. Walgreen is also one of America's largest companies by revenue, and it would be a major loss for the U.S. if the company's tax inversion plan is successful. Therefore, don't be surprised to see some political backlash and controversy, especially when a quarter of all Walgreen's revenue comes from taxpayer-funded programs like Medicare and Medicaid.
In the end, this could bode well for Rite Aid and CVS. Like Walgreen, CVS has enjoyed rapid growth over the last couple years behind higher prescription dispensing rates. During CVS's last quarter its total revenue grew 6.3% due to a 10.3% increase in Pharmacy Services .
Despite this strong U.S. growth, it's worth noting that CVS too has recently sought an emerging market presence, currently in talks to acquire the Brazilian drug company Drogarias Pacheco São Paulo after its initial $2 billion bid was rejected . It's also worth noting that Brazil's corporate tax rate was lowered from 34% last year to 25% in 2014.
Hence, CVS might be flirting with the same strategy as Walgreen, although more delicately. On the other hand, Rite Aid is not making moves to relocate, as it continues to execute its restructuring program to match the margins of its peers. Over the last 12 months Rite Aid's operating margin has been 3%, significantly lagging Walgreen's 5%; Rite Aid's implied revenue growth of 2% this year also lags its peers.
However, if there is backlash from Walgreen's move, Rite Aid and CVS could benefit from new customers, pushing both stocks even higher.
By all measures, Walgreen acquiring Alliance and relocating to Europe looks wise for shareholders, and is an action that could lead to higher revenues for its peers. In retrospect, Walgreen would likely trade revenue in the U.S. for higher margins and penetration into a much larger global market. When all is said and done, it's hard not to like Walgreen long-term, especially given the $4 billion in savings over the next five years.
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