Is your portfolio feeling a little green around the gills, and looking less so on your computer screen? Perhaps a visit to the local pharmacist is in order. It just so happens the doctor is in at Walgreen (NYSE:WAG), which reports its fiscal Q3 2006 earnings on Monday.

What analysts say:

  • Buy, sell, or waffle? 19 analysts follow Walgreen, with ratings splitting 14 to five, buy vs. hold.
  • Revenues. They're looking for Walgreen to post 12% sales growth to $12.1 billion.
  • Earnings. 10% profits growth to $0.44 per share is expected.

What management says:
On June 5, Walgreen announced its largest acquisition in two decades: privately held pharmacy chain Happy Harry's and its 76 locations along the Atlantic Coast. "Largest," however, is a relative term. Weighed against Walgreen's existing 5,200-odd locations, Happy Harry's is just an eyedrop in the bucket. According to fellow Fool Ryan Fuhrmann's write-up, the deal may add all of one penny to Walgreen's expected $1.70 per share in profits for this year.

In other news, Monday may be the last time we hear from Walgreen CEO David Bernauer in an earnings report. In July, Bernauer will cede the CEO post to current President Jeffrey Rein but retain his existing post as chairman of the board. It's hard to imagine a more experienced CEO that Walgreen could have picked. Rein has been with the company for nearly a quarter of a century, working his way up from assistant store manager into the executive ranks, and is currently both President and COO.

What management does:
It's steady as she goes on the margins front. Gross, operating, and net margins haven't varied much from quarter to quarter (on a rolling basis) for well over a year.

Margins %

11/04

2/05

5/05

8/05

11/05

2/06

Gross

27.4

27.7

27.9

27.9

28

28

Operating

5.8

5.8

5.9

5.7

5.6

5.7

Net

3.7

3.7

3.8

3.7

3.6

3.6

All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
When reviewing a company's margin trends, I like to use the above format, because it helps to smooth out the picture over time. The downside to using rolling, or trailing-12-month results, though, is that it can obscure short-term trends until they become long-term trends. At Walgreen, the short-term trend we've seen in margins is for the cost of goods sold to track closely with revenue growth, resulting in stable, growing profits, and the ultra-stable gross margins you see above.

But we're also seeing operating costs outpace sales growth, 12% to 10% over the last six months. As a result, despite Walgreen expanding its gross margin ever so slightly over the last 18 months, operating margins and net margins have dipped. The source of the higher operating costs seems to be concentrated in two areas: expensing of stock options and costs to open new stores. Time should take care of the former, as we begin comparing quarters-in-which-options-were-expensed to quarters-in-which-options-were-expensed (or if you prefer tired metaphors, apples-to-apples). The latter may be more of a concern. Yes, it costs money to open stores, but you'd also hope to see those stores generate revenues sufficient to match the increased costs that their opening entails.

One final thing to be on the lookout for, trend-wise: Walgreen mentioned that its gross margin weakened slightly in fiscal Q2 because its prescription mail service and the new Medicare drug benefit comprised a larger percentage of its total sales. Walgreen noted that these segments have lower gross profit margins than its other pharmacy lines. If over time they begin comprising even larger portions of Walgreen's total sales (as you'd expect, given our aging population), this could depress gross margins further.

Competitors:

  • Caremark (NYSE:CRX)
  • CVS (NYSE:CVS)
  • Dollar General (NYSE:DG)
  • Rite-Aid (NYSE:RAD)
  • Target (NYSE:TGT)
  • Wal-Mart (NYSE:WMT)

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Fool contributor Rich Smith does not own shares of any company named above.