Walgreens (NYSE:WAG), the largest drugstore chain in the U.S., reported sales for the month of May as well as Q3 2014 (ended May 31), earlier this week. Having lost its positive growth momentum in 2012, Walgreens’ top line growth re-accelerated since the company resolved its dispute with pharmacy benefits management company Express Scripts in September 2012. Despite a soft macro environment, Walgreen started its fiscal 2014 on a strong note and has retained its growth momentum so far this year. Its calendar 2014 year-to-date sales for the first five months stand at $31.9 billion, a 5.5 % increase over the same period last year.
As of May 2014 end, Walgreen operated 8,683 locations across 50 states in the U.S., the District of Columbia, Puerto Rico, Guam and the U.S. Virgin Islands. A large footprint places the company in a strong position to benefit, both from an aging U.S. population and from the Affordable Care Act’s expansion of insurance to millions of Americans.
Our price estimate of $64 for Walgreens is at a 15% discount to the current market price.
May & Q3 2014 Sales
Walgreens reported sales of $6.57 billion for the month of May, a 6% annual increase. Sales in comparable stores grew 4.4% and prescriptions filled at comparable stores increased by 3.5%. Pharmacy sales accounted for 64.3% of the total sales for the month, and witnessed a 7.9% annual growth. Comparable store pharmacy sales increased 5.5%. Total front-end sales and comparable front-end sales increased 3% and 2.6%, respectively. Though customer traffic in comparable stores declined by 0.5%, basket size increased 3.1%.
Walgreens’ total sales for Q3 2014 were $19.47 billion, 6.4% higher compared to Q3 2013. Comparable store sales for the quarter increased 2.2%. Front-end comparable store sales grew 2.2%, whereas prescription filled at comparable stores increased by 4%.
Generic Substitution To Increase In The Second Half
Generic drugs are comparatively lower priced than branded drugs, and thus put pressure on Walgreen’s top line growth. The company has benefited from a lower generic substitution in the last few months. The total generic dispensing rate, which factors the percentage of generic drugs in a consumer’s prescriptions, grew to 78.5% in 2012, from 74.1% and 71.5% in 2011 and 2010, respectively. The generic wave peaked in Q1 2013 and hit a trough in Q1 2014.
Generic drug substitution had a 1% negative impact on comparable prescription sales in Q2 2014, compared to a 1.3% and 6.0% negative impact in Q1 2014 and Q2 2013, respectively. However, in its last earnings call, Walgreen mentioned that it anticipates the rate of decline in new generics introductions to moderate in Q3 2013 and turn positive towards the end of the year. Calendar day-shift adjusted comparable store pharmacy sales were negatively impacted by 1.3% (slightly higher than Q2 2013) due to generic drug introductions in the last 12 months.
An estimated $15 billion worth of branded products will come off patent in the next three years, opening them to competition from generic drugs.  This can put pressure on Walgreen’s top line growth as generic drugs are cheaper compared to branded drugs.
The agreement with AmerisourceBergen (ABC) allows Walgreen to jointly source generic drugs and generate logistical efficiencies. By combining its distribution in the United States and Europe with ABC, Walgreens will be able to negotiate better prices for generic drugs. The Walgreen-ABC alliance has the strongest generic purchasing power, which allows them to buy generic drugs at cheaper prices in the U.S. and expand aggressively in the European market. (Read: With The Highest Generic Purchasing Power, Walgreen To Benefit From Rising Generic Sales)Notes:
- CVS Caremark’s CEO Discusses Q2 2013 Results – Earnings Call Transcript, Seeking Alpha, August 6, 2013 [↩]