Walgreen’s Earnings Confirm Its Renewed Growth Momentum

Walgreen (NYSE:WAG), the largest drugstore chain in the U.S., reported its Q4 2013 and year end results on October 1. The company closed its fiscal 2013 with $72.2 billion in sales, a 0.8% annual increase, and witnessed a 13.7% rise in its operating income. Its revenue base declined in fiscal 2012 as its dispute with pharmacy benefits management company Express Scripts led to a significant loss in the number of Express Scripts’ prescriptions filled at Walgreen stores. However, following the dispute resolution between the two companies in September 2012, Walgreen has seen its growth accelerate in subsequent months.

For Q4 2013, Walgreen reported a 5.1% y-o-y growth in sales ($17.9 billion) as the negative impact of generic drugs slowed down. Despite the lower generic drug penetration, higher margins from these products combined with Walgreen’s cost cutting measures led to a 75.3% y-o-y growth in Walgreen’s operating income for the quarter. The company witnessed a 6.4%, 1.6% and 4.6% rise in its comparable prescription sales, comparable front-end sales and total comparable store sales respectively.

Improving customer value, providing innovative products and services, developing a systematic globalized offering and designing the most relevant network and formats are four key focus areas for Walgreen. With 8,585 stores operating across the U.S., the District of Columbia, Puerto Rico and Guam, Walgreen is in a strong position to gain from the Affordable Care Act expanding insurance to millions of Americans. Additionally, with new partnerships expanding its footprint in international markets Walgreen aims to become a leading global pharmacy.

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Regained Market Share In Prescriptions Filled

On account of its dispute with Express Scripts, Walgreen’s market share in total prescription filled in the US declined from 19.6% in 2011 to 17.4% in 2012 (calendar year). However, the company claims that it filled a record 821 million retail prescriptions in fiscal 2013 which translates into a 19.1% market share. The dispute resolution with Express Scripts and introduction of new programs helped the company regain its lost market share in fiscal 2013.

Recently, Walgreen and Express Deals launched a new prescription drug program called Smart90 Walgreens. Smart90 Walgreens is a 90-day prescription drug program which offers plan members convenient access to in-person pharmacist consultations and a wide-range of health and wellness services that can improve medication adherence and lower overall healthcare costs. It provides customers the option to receive their maintenance medications through Walgreen’s retail pharmacy or Express Scripts home delivery service.

In addition to returning Express Scripts prescriptions, Walgreen believes that its preferred relationship with top Medicare Part D plans helped it improve market share with older Americans, a customer segment expected to rise in the future. The U.S. Census Bureau projects that within the next two decades, the proportion of total population over 65 years will increase from 13% to 19%, whereas those between 20 years and 65 years of age will decline from 60% to 55%. In its earnings call, Walgreen declared that its Medicare Part D share grew by 1.2% in fiscal 2013. ^[1]

Lower Negative Impact By Generic Drugs Introduction

Generic drugs are comparatively lower priced than branded drugs. The total generic dispensing rate, which implies the percentage of generic drugs in a consumer’s prescriptions filled, grew to 78.5% in 2012, from 74.1% and 71.5% in 2011 and 2010, respectively. Generic drugs had a 2% negative impact on Walgreen’s comparable prescription sales as compared to a 9% negative impact in Q1 2013.

Walgreen anticipates low rate of introduction of new generics in the first half of fiscal 2014. Nevertheless, an estimated $15 billion worth of branded product will come off patent in the next three years, opening them to competition from generic drugs. Thus, we expect generics to continue to offset Walgreen’s top-line growth in the future as well, albeit at a slower pace.

New Partnerships To Help Expand Global Operations

Aiming to become a leading global pharmacy Walgreen is pursuing new market opportunities, expanding its brand portfolio and optimizing its global supply chain.

In August 2012, Walgreen completed an initial 45% investment in Alliance Boots, the largest European pharmacy-led drug retailer, with an aim to create a global pharmacy by expanding its operation in new markets including Europe, China, Latin America, etc. It achieved $154 million in combined net synergies with Alliance Boots in fiscal 2013 and estimates combined synergies in the range of $300 – $400 million for fiscal 2014.

Recently, Walgreen entered into a 10-year agreement with AmerisourceBergen (ABC) to jointly source generic drugs and generate logistical efficiencies. ABC provides drug distribution and related services designed to reduce costs and improve patient outcomes. Early last month, Walgreen transitioned the distribution and delivery of branded pharmaceuticals to ABC. By combining its distribution in the United States and Europe with ABC, Walgreen will be able to negotiate better prices for bulk drugs. Walgreen anticipated to realize full benefits of lower distribution costs by fiscal 2015.

This year Walgreen also launched a joint venture in Berne, Switzerland and achieved $154 million in combined net synergies for fiscal year 2013.

We are in the process of updating our price estimate of $45.36 for Walgreen.

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1. Wagreen Company Q4 2013 Earnings Call Transcript, Morning Star, October 1, 2013 [↩]