Talk about your pleasant surprises. Walgreen (NYSE: WAG) certainly gave one to investors in the beleaguered drug store giant on Tuesday. The company handily beat Wall Street estimates of $0.44 per share for its fiscal fourth-quarter results, reporting earnings of $0.49 per share, or $470 million. Same-store sales ticked up 1.6%.
The earnings look even more impressive given the terrible quarterly results that smaller competitor Rite-Aid (NYSE: RAD) posted just last week. Many expected similar results from even the stronger drugstores, as drugstore chains have been struggling to draw in a more discretionary consumer. CVS Caremark (NYSE: CVS) also rallied on the heels of the Walgreen news, while investors were still unwilling to overlook Rite-Aid's operational woes.
Drug sales up
The real bright spot for Walgreen was the large increase in prescription drug sales and volume, well above the industry trend. Brick-and-mortar drugstores have been steadily losing this business to online pharmacies and big-box discount retailers such as Costco (Nasdaq: COST), Wal-Mart (NYSE: WMT), BJ's (NYSE: BJS), and Target (NYSE: TGT). Prescription sales account for about two-thirds of the company's revenue.
Walgreen prescription drug sales increased by 6.5% over the previous year. Prescription volume also increased by 3.3%.
During the economic downturn over the past few years, U.S. consumers have been making fewer visits to the doctor in order to save money. This has resulted in fewer prescriptions. So the prescription upswing is not only a positive sign for the company, but the economy as well. Still, the company's pharmacy business is being pushed by tightened reimbursement rates, making drug sales less lucrative. However, at Walgreen lower reimbursement rates were offset somewhat by more generic prescriptions.
Customer-centric retailing
At the front end of the store, Walgreen is also seeing big improvement in part thanks to its store revamp program known as Customer Centric Retailing. Walgreen has converted more than 1,500 company stores into this new customer-enhanced store format, while also opening nearly 300 more CCR format stores this year. Company President and CEO Greg Wasson spoke about the success of the CCR conversions on the conference call:
CCR is reducing working capital and store labor. And most importantly, it is improving sales and the overall shopping experience by optimizing and enhancing our existing product assortment by improving category and product adjacencies through improving site lines throughout the store, and by refreshing all our stores with a new in-store decor package.
Walgreen has maintained a cost of about $50,000 per store conversion, and the investment has been paying off. According to Wasson, the pilot stores have been outperforming non-converted stores by 3.7% over the past 26 weeks.
The Foolish bottom line
While Walgreen management should be applauded for posting a tremendous quarter in a difficult business environment, investors should still be aware that the cash-strapped consumer remains a headwind for the industry. Wasson said as much on the call noting that, "We still have a tight consumer."
That being said, Walgreen is the best of a struggling breed, and as its CCR initiatives and the large Duane Reade transition commences in 2011, Walgreen is in a great position.
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