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Investment Overview for Walgreen Co. (NYSE:WAG)
Recent Developments
In June 2012, Walgreen acquired a 45% stake in European pharmacy business Alliance Boots for $6.7 billion, paying $4 billion in cash and 83.4 million in shares and it intends to acquire the remaining stake by 2015. The deal was received with investor skepticism about the cost and timing of the deal and the risks associated with increased exposure to current European economic uncertainties and increase in debt (~$11 billion). Nonetheless, Walgreen sees long-term sense in the trans-Atlantic alliance as the deal creates the first global pharmacy business with 11,000 stores in 12 countries. It provides Walgreen with a large platform for further international expansion based on Alliance's experience in expanding into new markets such as China and Latin America, along with the opportunity to turn Alliance Boots into a global wholesaler. Walgreen also expects the deal to provide cost and revenue benefits of $100 million to $150 million in the first year and $1 billion by the end of 2016 for both the companies. The two together will also be the world's largest buyer of prescription drugs and health products which will give them leverage to negotiate better prices for generic drugs and other non-pharmacy products.
Alliance Boots is the largest European pharmacy-led drug retailer and health and well being products seller that generated $40 billion (£25 billion) in revenue and $2 billion in operating income in 2011, and we believe the market may be discounting the combined entity's lone-term earnings and growth potential over short-term uncertainties. Nonetheless, integrating a company of the size of Alliance Boots is unprecedented and a challenging task for Walgreen.
In July 2012, Walgreen acquired a 144-store strong regional drug retail chain, USA Drug, owned by Stephen L. LaFrance Holdings Inc., in a $438 million mostly-stock deal. The retail chain includes names such as USA Drug, Super D Drug, May's Drug Stores, Med-X Drugs and Drug Warehouse and has a major presence in mid-Southern United States. The 144 stores posted sales of about $825 million in 2011.
In March 2013, Walgreen and Alliance Boots, furthering their relationship as “Earth’s Drugstore” signed a deal with U.S. distributor AmerisourceBergen that will pool purchasing power to buy generic and branded prescription drugs around the world. The 10-year agreement with AmerisourceBergen, is worth $28 billion in fiscal 2014 and will bring an end in August'13 to Walgreen’s relationship with rival distributor Cardinal Health. Walgreen currently distributes more than 80 percent of its own drugs but over time most if not all of that distribution will be handled by AmerisourceBergen.
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Walgreens's Share of Retail Prescriptions Filled in the US: Walgreens' share of the total prescriptions filled in the US declined to 17.4% in 2012 as a result of its dispute with Express Scripts and loss of a major chunk of the corresponding 90 million prescriptions. The two reached a fresh agreement to allow Express customers fill prescriptions at Walgreen stores, starting September 15, 2012. Accordingly, we expect the market share to improve back to 18.1% in 2013, assuming Walgreen succeeds in winning back old customers post the disruption. We believe the market share could gradually improve to historical levels of 19.5% over our forecast period based on the strength of its retail network as well as an increase in online sales post the acquisition of Drugstore.com. If, however, Walgreen's market share in retail prescriptions stays close to the 18% level due to slow growth, inability to attract lost and sticky customers or loss of more business, there could be a 5% downside to our current price estimate.
EBITDA Margin for Prescription Drug Sales: We currently forecast the EBITDA margins for prescription drugs sales to rise consistently over our forecast horizon from 10% in FY 2011-12 to about 11.5% over the next few years. This increase is largely expected due to higher pharmacy margins resulting from an increase in generic drug sales, cost savings resulting from Walgreen's restructuring initiatives and greater buying power as a result of the agreement with AmerisourceBergen. Sales of lower priced generic drugs are expected to increase faster than branded drugs with patents for a large number of branded drugs expiring in the near future (eg. Pfizer’s Lipitor drug with $11 billion in annual sales lost patent protection in Nov 2011). Over the next three years, over $170 billion worth of drugs would lose patent protection, opening them to generics and driving higher margins. Gross profit dollars are approximately 50% higher on generic drugs than on the branded drugs. With the generic wave, each script is expected to bring an incremental $5-7 in profits, allowing up to 10% growth in EBIT margins. If, however, there is increased reimbursement pressure from Pharmacy Benefit Managers (particularly in light of the ongoing industry consolidation) and the gross margins stay close to the current levels, there could be a 10% downside to the Trefis price estimate.
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Walgreen is the largest drugstore chain in the US, which sells both prescription and non-prescription drugs as well as retail merchandise (cosmetics, convenience foods, photo processing services, seasonal merchandise). In addition to its store offerings, Walgreen provides pharmacy services like prescription fulfillment through mail order, telephone and internet.
Walgreen operates the largest network of over 8500 locations across the US, with over 75% of US population living within a five mile radius of a typical Walgreen retail store.
Walgreen's operational efficiency is noteworthy as its average chain wide retail sales per square foot is approximately $800, higher than that of Wal-Mart and other retail stores that sell drugs and general merchandise. Of these, around $300 come from general merchandise sales. Prescription drug sales account for over 60% of total revenues for Walgreen.
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Prescription drug sales are the biggest source of value for Walgreen Co., accounting for close to two-thirds of its total value.
Accessibility and affordability by virtue of largest U.S. drugstore network
Walgreen has the largest network of over 8500 pharmacy locations conveniently located within a five mile of nearly three-quarters of all Americans.
Walgreen's health service providers communicate face-to-face, on a personal level, with patients in ways to improve overall health care outcomes. Walgreen stores prove to be convenient, easily accessible and more affordable to its customers as a result of their significant scale and deeper penetration in the U.S. pharmacy market.
Poised to rake in higher sales than any U.S. retailer
Because of its strong market position Walgreen has over $800 in retail sales per square foot out of which prescription drug sales generate about $500 per square foot. This is higher than Wal-mart's $400 sales per square foot.
Walgreen has 18% share of retail prescriptions filled in U.S. and it is expected to increase in the future as Walgreen's pace of new store additions is expected to be higher than that of any other US retail drugstore chain. Walgreen thus has a highly advantageous and strong positioning among all the drug retail chains.
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Increasing demand and utilization of prescription drugs in the U.S.
The U.S. has an aging population, and as older people contribute to a larger proportion of expenditure on drugs (people above 60 spend an average 2-3 times more than those below 40), this will lead to an increase in the prescription drugs market in the U.S. The 2010 U.S. health reform legislation is also expected to increase prescription drug sales, as over 30 million uninsured Americans will gain coverage and the U.S. government will accordingly increase outlay on prescription drugs. This will be driven by an expansion of Medicaid and Medicare Part D plans.
Accelerating sales of generic drugs to positively impact margins
Sales of lower priced generic drugs are expected to increase faster than the sales of branded drugs. This growth will be supported by the fact that patents for a large number of branded drugs will expire in the near future (For example Pfizer’s Lipitor drug with $11 billion in annual sales lost patent protection in Nov 2011). Expansion of generic drugs in the U.S. market will impact retail pharmacy gross margins as they have a lower cost but higher margins compared to those of branded drugs. Gross profit dollars are approximately 50% higher on generic drugs than on the branded drugs, and with the generic wave, each script will bring an incremental $5-7 in profits, allowing up to a 10% growth in EBIT margins.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
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