Remember all the times you made a New Year's resolution to get in shape? How often did your initial enthusiasm last longer than a month? Your fitness initiative may have petered out somewhere around the Super Bowl, but it seems that Walgreen (NYSE: WAG ) is far more serious about slimming down.
After reporting less-than-stellar earnings in October, Walgreen made an early New Year's resolution to trim the expense-growth fat. In the words of Chairman Jeffrey Rein, "our expenses weren't in line with the level of reimbursements we were receiving ... we're going to fix that." This time around, the company showed that it's serious about making that resolution stick in 2008.
Sales growth was 10.4%, while comparable-store sales advanced 5.4%, right in line with the company's recent trends. Despite generally soft retail sales, Walgreen remains a comp machine.
The drag on earnings this quarter came from product margin, which slid 29 basis points because of a greater proportion of sales from the lower-margin pharmacy business. Gross margin was also hurt by a sales shift toward lower-margin front-end items.
However, the company managed to control selling, general, and administrative expenses, primarily thanks to lower legal, insurance, and store- closing costs. Management's cost-cutting focus ultimately paid off; SG&A increased 9.5% year over year, less than the rise in sales. In the end, earnings per share of $0.46 beat analyst expectations by $0.02, up 7% from last year.
The company opened a record 169 new stores this quarter, and it intends to expand the store base by 475 net locations next year, translating into a 7.7% larger worldwide footprint. This keeps Walgreen on track toward its goal of 7,000 stores by 2010, with the long-term potential for roughly 13,000 stores in the U.S.
Walgreen also intends to operate 400 Take Care Health Clinics inside its stores by the end of next year, tripling the current count. At this pace, Walgreen is about a year behind CVS (NYSE: CVS ) , which will reach 400 Minute Clinic locations at the end of 2007.
Walgreen stock has taken it on the chin the past few months, even as CVS stays in the zone. Rite Aid (NYSE: RAD ) and Longs Drug (NYSE: LDG ) are chugging along, but are hardly in the same league as the two huge players. Discounters like Wal-Mart (NYSE: WMT ) and Target (NYSE: TGT ) offer the same merchandise, but I doubt they can match the convenience and service profile of a neighborhood pharmacy with a health-care clinic on-site.
I remain bullish on the retail pharmacy channel. This quarter's earnings release will likely reassure investors that Walgreen is back in shape.
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