Will Walgreen's (WAG +0.00%) stock mount a comeback after disappointing investors in early August? The shock of the giant pharmacy retailer's decision to forego a financially advantageous tax inversion seems to have worn off. Walgreen's August sales results helped ease the pain somewhat. The stock isn't out of the woods yet, though. Here are three reasons Walgreen's shares could potentially resume a downward path.
Source: The Motley Fool
1. Activists not active enough
Recent board of director appointments have been a positive sign for some observers of Walgreen. The company announced this week that activist investor Barry Rosenstein, managing partner of hedge fund Jana Partners, joined its board. Jana Partners will also get to name another person to the pharmacy retailer's board. The hedge fund owns around 1% of Walgreen's shares.
Rosenstein and the second Jana Partners appointee will no doubt stir things up in Walgreen's board room. Their voices could prod the company to be more responsive to many shareholders' concerns. However, it's unlikely that the decision to stay in the U.S. rather than relocate overseas for tax gains will be revisited.
There's even a real possibility that the addition of the two new board members won't have a substantial change on Walgreen's direction. If the activists on the board prove to be less active than some investors expect, it could be a factor in Walgreen's shares resuming the previous decline.
2. Margins become more marginal
August sales results looked good overall. Walgreen's notched an increase of 3.6% year over year to $6.16 billion. Pharmacy sales, which account for nearly two-thirds of overall sales, jumped 5.4%. Those increases would have been even better except that this August had one less weekday and one additional Sunday compared to last year.
One potential Achilles' heel stands out with Walgreen's sales results announcement, though. Margins are under intense pressure. Gross profit margins were down last quarter and will likely be lower again in the fourth quarter, which ended on Aug. 31.
What's behind these lower margins? One big factor is that some generic drug prices have gone up rather than down. Another is continued pressure on reimbursement rates. Walgreen's is also seeing a shift toward 90-day prescription refills. The company makes higher profits on more frequent refills. Should these issues manifest themselves more than expected when Walgreen announces fourth-quarter earnings on Sept. 30, the company's shares could join its margins in falling.
3. Failing at stopping the failing
Two high-profile Walgreen failures made headlines in just the last few weeks. On Aug. 20, CFO Wade Miquelon left the company after a $1 billion forecasting error in the company's Medicare business. Last week, Walgreen had to deal with a computer glitch that resulted in thousands of customers with potentially unreadable drug labels. Both stories were initially reported by The Wall Street Journal.
You might think that a CFO hitting the road after a billion dollar mistake might hurt shares. Nope. Neither did the computer problem potentially affecting thousands of customers. Walgreen's stock hasn't moved much despite these problems.
Should these types of failures continue, though, I suspect that shares will suffer. Warren Buffett's words about Johnson & Johnson back in 2012 come to mind. After the pharmaceutical and consumer products company announced several recalls and other problems, Buffett said, "It's still got a lot of wonderful products and it's got a wonderful balance sheet and all of that, but there have been too many mistakes made." He later sold his shares of J&J. Too many mistakes can hurt.
Negating the negatives
Walgreen's stock could fall for any of the above reasons -- and there are more that could cause problems as well. However, I'm not too negative about the stock over the long run. Actually, my view for Walgreen is positive overall.
The Alliance Boots acquisition should prove beneficial over time. Macro trends like an aging population will drive revenue higher. Health reform could continue to be the gift that keeps on giving to pharmacy retailers, including Walgreen. I like the company's expansion into healthcare clinics. Walgreen's long-term future should be bright. It's the near term that is still murky for now.
