Growing consistently is nothing new for Walgreen
The company's 2005 fiscal year concludes in August, and nine-month results point to more stellar results. Comps have grown 8%, with revenues up 13%, and profits rising 20%. Even at this price, I believe the company's a worthy investment; I think its best is yet to come.
Improving margins
In the past three years, Walgreen improved sales by 14% annually, but managed to grow profits only 16% -- mostly due to higher tech spending. (Earnings should normally grow faster than revenues. If a company isn't at least getting better pricing, it should be able to better leverage fixed operating costs.) However, based on the first nine months' results, I'd estimate that 2005 revenues will grow 13%, gross margins will improve from 27% last year to 28%, and we should accordingly see a bump in earnings to 21% compared to 2004.
Walgreen gets 65% of its revenues from prescriptions, and most of this year's gross and net margin improvements have come from a surge in generics sales. Despite their lower prices, generics earned much more than branded pharmaceuticals for the chain. Digital photography sales also did their bit for better margins from front-end sales.
Competitors lack the dosage
Investors continue to favor Walgreen with a higher multiple primarily for its operational strength, especially compared to pure-play drugstore chain competitors CVS
In 2005, Walgreen should earn $42 billion from an estimated 4,947 stores, while CVS is expected to limp in with an insipid $37 billion from 5,525 stores. For 2005, I estimate $8.54 million average sales per store for Walgreen vs. $6.69 million for CVS -- an impressive 27% difference.
I also expect Walgreen to grow 2005 same-store sales by 8% -- a conservative estimate based on 8.6% comps growth for the first nine months. Based on six-month figures, I predict CVS will lag behind with 6.9%. (This number does not include Eckerd sales; CVS said it expects only a modest increase in comps once those stores are included.)
For 2005, I'd anticipate prescription comps growth of roughly 11%, based on nine-month comps coming in at 10.5%. That's just about 30% higher than CVS' estimated growth, even though prescriptions compose 70% of CVS' revenues compared to Walgreen's 65%.
At 27.9%, Walgreen's gross margin beats CVS' 26.3% for the trailing 12 months. Since CVS' interest payments take a bigger chunk out of revenue, Walgreen also boasts fatter net margins: 3.8% to CVS' 2.9%.
|
Walgreen |
CVS |
|
|---|---|---|
|
FY Estimates |
Aug. 05 |
Dec. 05 |
|
Stores |
4,947 |
5,439 |
|
Revenues in millions |
$42,267 |
$37,000 |
|
Rev. per store in millions |
$8.54 |
$6.69 |
|
Comps growth % |
8.1 |
6.9 |
|
Prescriptions comps growth % |
10.9 |
8.4 |
|
Pharma. revenue % |
65 |
70 |
|
Debt/equity |
0 |
.37 |
|
Gross margins |
27.9 |
26.3 |
|
Net margins |
3.8 |
2.9 |
Rite Aid -- the most significant competitor for both Walgreen and CVS -- sports $16 billion in sales and a debt-to-equity ratio of 8 to 1. With those numbers, it would need a serious shot in the arm to compete with its two larger rivals.
Price concerns
If investors buy Walgreen shares now, will they be overpaying? After all, this is a commoditized business. Drugstores generally look the same on the inside, have similar prices, and offer the same basic quality of service. In addition, Marketresearch.com lists more than 50 chains, including the ubiquitous Wal-Mart
Even prime locations are not impregnable moats. My neighborhood in Queens, New York, has two Duane Reades, one Walgreens and about 27 independents jostling for customers within a one-mile radius -- not to mention two hospitals. The Walgreens store happens to be on my way back from the doctor and is the closest to my home; shopping there has more to do with convenience than loyalty for me.
As the population ages, and we get more predictable in ordering the same pills we're going to pop every year, I suppose there will be more mail and Internet prescription orders. However, as nearly every drugstore chain already offers these options; revenues from these segments should increase in line with the overall market.
I don't see any threats to the Walgreen business model from Internet or mail-order deliveries. The company has the operational strengths to capture growth from these channels as capably as its competitors. While the overall prescriptions market experienced a compounded annual growth rate of 7% over the last decade, Walgreen's growth nearly doubled that with roughly 12%.
Using its cash well
In my opinion, Walgreen's consistent growth stems from a measured, strategic expansion strategy that avoids rushing into bad locations. The company has a foothold in high-growth states with large aging populations, including a 67% share of the key Texas and Florida markets. Walgreen has also carefully chosen locations to build its own stores, instead of buying out other chains. It's forsaking a quick buck for long-term strategic growth.
Walgreen expects to continue opening about 400 new stores each year. It generates about $2 billion in operating cash, spends half on expansion, and shares the rest with stockholders in the form of buybacks and dividends. Investors have been amply rewarded in the past five years; Walgreen's most recent buyback initiative, from earlier this year, has about $600 million left to go.
Earnings growth anywhere short of 22% to 25% may disappoint a lot of investors. At $48, you're paying more than 30 times analysts' most recent estimated earnings of $1.55 per share. However, given Walgreen's market leadership and considerable advantage over competitors, its position seems very solid. If the share price declines, I'd happily prescribe Walgreen to interested investors.
We've prescribed related Foolishness:
Fool contributor Bobby Shethia always has trouble opening a childproof prescription bottle. He usually asks his 7-year-old to help. He doesn't own any shares of the companies mentioned in this article, but plans to buy Walgreen shares after the waiting period. The Motley Fool is investors writing for investors.
