Walgreen Will Retain Its Growth Momentum In Q3’14

Walgreen (NYSE:WAG), the largest drugstore chain in the U.S., is set to report its fiscal Q3 2014 earnings on June 24. (Fisca years end with August.) The company’s top line growth has re-accelerated since it 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.

Beating the negative impact of severe weather conditions, Walgreen reported 5.1% year-over-year growth in its Q2 2014 earnings. Walgreen’s strong performance last quarter can be attributed to its strong fundamentals, the return of Express Scripts customers and the company’s ongoing progress in winning new Medicare Part D customers. The company retained it growth momentum in Q3 2014, as is evident from strong sales for the quarter (reported on June 5). Total sales for Q3 2014 were $19.47 billion, 6.4% higher compared to Q3 2013.

Walgreen believes that focus on its three strategic growth drivers — i.e., creating a Well Experience, advancing the role of the community pharmacy and establishing an efficient global platform — help it become a leading global pharmacy. As of May 2014, it 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 the Affordable Care Act’s expansion of insurance to millions of Americans.

Our price estimate of $64 for Walgreens is at an approximate 10% discount to the current market price. We will update our valuation for the company after the Q3 2014 earnings release.

View our analysis for Walgreens

Wellness Format Stores Spur Growth

In 2011, Walgreen introduced its Well Experience store format, which offers an enhanced layout, a new products selection, and a completely revamped pharmacy and health care experience. Through the active interaction of team members and a new Health Guide role, Walgreen aims to enhance the overall customer experience at its stores.

Walgreen claims to have made significant progress on this initiative and currently operates the new format at over 600 Wellness stores. The company continues to refine its store format to integrate healthcare, provide an elevated beauty experience and deliver seasonal and consumable convenience to meet customers’ needs.

Walgreen filled a total of 214 million prescriptions (2.8% year-over-year growth) and its retail pharmacy market share increased by 20 basis points (to 19%) in Q2 2014. ^[1] Its Balance reward program hit a milestone, reaching 100 million enrollees in Q2 2014. With approximately 80 million active members, Walgreen has the largest retail loyalty program in the industry. The company plans to leverage the customer insights from its reward program to further advance its value preposition and enhance customer experience.

Generic Substitution To Increase In The Second Half; Walgreen Has The Highest Generic Purchasing Power

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 prescription, 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 2014 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 go off patent in the next three years, opening them to competition from generic drugs. ^[2] 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)

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1. Walgreen’s CEO Discusses Q2 2014 Results – Earnings Call Transcript, Seeking Alpha, March 25, 2014 [↩]
2. CVS Caremark’s CEO Discusses Q2 2013 Results – Earnings Call Transcript, Seeking Alpha, August 6, 2013 [↩]