Uncle Sam might be happy with Walgreen Company (NASDAQ: WBA ) these days, but Wall Street isn't. After starting off 2014 with hefty gains of over 25%, Walgreen Company stock dropped 14% on Aug. 6 and is still seemingly stuck in the doldrums. Is this pullback a buying opportunity for investors?
Getting the boot
Walgreen's management hinted earlier this year that "step two" of its joint venture with Alliance Boots -- a full-blown merger of the companies -- could be on the way. Alliance Boots is headquartered in the United Kingdom but domiciled in Switzerland. Many investors expected the merger would include an inversion deal that would allow Walgreen to move its base to Europe and escape the relatively high U.S. corporate tax rates.
Few were surprised when Walgreen announced on Aug. 6 that "step two" was moving forward and that it would buy the remaining 55% of Alliance. However, many were taken aback that the giant pharmacy retailer opted to remain domiciled in the U.S. Walgreen got Alliance Boots, but in the process the market gave its stock the boot.
Walgreen paid $1.45 billion in income taxes in its last fiscal year. A tax inversion deal could have saved it around $4 billion over the next five years. However, the decision to forego that tax advantage made Walgreen Company stock lose over $9 billion in market cap overnight.
Of course, all of this assumes that Walgreen could have successfully navigated the hurdles for an inversion transaction. After an extensive review, the company's management and board concluded that it faced an uphill battle convincing the IRS that such a move met its requirements.
The risk of losing market share to competitors was another factor in Walgreen's decision. CVS Caremark counts over 7,700 stores -- a close second to Walgreen's almost 8,200 stores nationwide. Rite Aid lags behind but still boasts around 4,600 locations. Both CVS and Rite Aid would have likely jumped to capitalize on a potential backlash against Walgreen had it officially moved its headquarters outside of the U.S.
All of this discussion is a moot point now, though. Walgreen is staying in the U.S. The question of whether or not the stock is a buy doesn't hinge as much on its corporate tax rate as it does on how well Walgreen can compete against the likes of CVS and Rite Aid in winning consumers' business.
On that front, Walgreen appears to be doing just fine. Its July sales jumped 6.1% year-over-year with prescriptions filled at comparable stores increasing by 3.7%. By comparison, Rite Aid reported July sales were 4.6% higher versus a year ago with prescription count at comparable stores up 3.9%. CVS doesn't report monthly results.
All three big pharmacy chains are aggressively expanding their business models to provide more healthcare services. Walgreen's Take Care Health Systems subsidiary manages over 400 in-store care clinics. CVS operates over 800 healthcare clinics. Rite Aid is somewhat behind on this front, but the company bought RediClinic in April with plans to roll out clinics to its stores. Rite Aid also is in the process of renovating its stores with its Wellness model that supports offering more healthcare services.
Walgreen will certainly want to not get too far behind CVS in providing clinics in its stores. These clinics not only provide an additional avenue for revenue but can also drive increased prescription and retail sales. There's no need to worry that the company's management is asleep at the wheel with respect to this opportunity given Walgreen's continued expansion in this area.
Customers appear to like what Walgreen is doing. The company reported all-time high levels of its "customer delight" and "pharmacy delight" scores in the last quarter. Both metrics increased significantly compared to the same period in the prior year.
While Walgreen's headquarters is staying put, I suspect that its shares will be moving on up. The sell-off a couple of weeks ago seems a tad overdone in my view. It did, however, make the stock's valuation look more attractive than it's been in quite a while.
The acquisition of Alliance Boots should help boost the bottom line with its synergies of around $1 billion by fiscal 2017. An aging population and healthcare reform should continue to propel prescription volumes. Expanded services like healthcare clinics should push revenue higher.
This American company has been successful for over a century. It has paid dividends for more than 81 years -- and keeps hiking those dividends ever-higher. Walgreen isn't going anywhere, but, like the Energizer bunny, its returns to investors keep going, and going, and going...
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