Walgreen’s Q1’15 Earnings Preview: Topline Continues To Grow Though Margins Remain Under Pressure

Walgreen (NYSE:WAG), the largest drugstore chain in the U.S., is set to report its Q1 2015 earnings on December 23th. The company continues to see growth in its daily living business and prescription volumes. It reported the largest quarterly and fiscal year sales increases in three years last quarter. It announced strong sales for  Q1 2015 earlier this month, retaining its topline growth momentum. For Q1 2015, comparable store sales increased 5.8%, while front-end comparable store sales increased 1.5%. Prescriptions filled at comparable stores increased 4.2% and comparable pharmacy sales increased 8.3% in the quarter.

While Walgreen’s top line continues to grow, it faces ongoing pressure on gross margins. The company believes that the margin pressure will persist in the short-term. A cautious consumer, ongoing reimbursement pressure, generic drug inflation and significant step-downs from Med D reimbursement rates, are some of the factors that will act as headwinds in fiscal 2015. Nevertheless, Walgreen believes that it is well-positioned to capitalize on the industry tailwinds, which include an aging population,  growth in chronic conditions, the consumerization of healthcare, continuing increases new generics and growing demand for a personalized experience.

Our price estimate of $64 for Walgreens is approximately 15% lower than the current price estimate. We will update our valuation after the Q3 2015 earnings release.

View our analysis for Walgreens

Walgreen Gained Share In The Retail Pharmacy Market In Fiscal 2014

Walgreen claims that its retail pharmacy market share grew 30 basis points to 19%  in fiscal 2014, as it filled a record 856 million prescriptions. It filled 211 million prescriptions in Q4 2014, 4.2% higher compared to the same period last year. According to IMS, Walgreen grew script 60 basis points faster than the retail industry in Q4 2014. ^[1] The company expects to continue to increase its pharmacy volume and share with high-value customers through growth in Med D, its enterprise specialty business and immunizations.

Since 2013, Walgreen claims that its prescription share with Med Part D seniors has grown more than twice as fast as the overall retail prescription share. On an average, Med D seniors fill three time more prescriptions compared to the company’s non-Med D customers. Walgreen is confident of increasing its share further in subsequent quarters, driven by a continued focus on winning high value seniors through preferred relationships with Medicare Part D plans.

Walgreen also intends to increase its share in the specialty market by improving and integrating care for patients with complex chronic disease states. As of August 2014 end, it had access to over 100 limited distribution drugs by manufacturers, which the company believes symbolizes the manufacturers desire to work with Walgreen’s unique specialty network of health system pharmacies, its complex therapy pharmacies and fusion pharmacies and its specialty  retail offering.

A new report released by CVS Health (NYSE:CVS) in November 2013 projects that specialty drug spending will more than quadruple by 2020, crossing $400 billion a year. Expanding its presence in the specialty sector will help increase Walgreen’s share in the overall pharmacy market, in our view.

Focus On Lowering Internal Costs To Improve Bottom Line

Though recent trends have put pressure on margins,  Walgreen’s constant focus on lowering its internal costs, in our view,  will help improve its bottom line in the long run. Though margins continue to grow at the front-end, the company’s pharmacy gross margin remains under pressure from: 1) higher third party reimbursement pressure; 2) increased Medicare Part D in the  business mix; 3) Walgreen’s strategy to continue driving 90-day prescriptions at retail; 4) pronounced generic drug inflation on a subset of generic drugs; and, 5)  the mix of specialty drugs. The company’s gross margins declined from 29.2% in fiscal 2013 to 28.2% in fiscal 2014.

Walgreen is focused on driving cost discipline across the company to offset the negative impact on gross margin. Apart from its ongoing store optimization efforts (shutting down the unprofitable stores), it is identifying additional opportunities to lower its expenses. The company expects to achieve $1 billion in cost reductions over three years by incorporating savings at the corporate field and store levels. It has put headquarters and non-labor spending reductions into immediate effect and continues to work toward greater efficiencies in its processes through Walgreens lean Six Sigma. Additionally, positive synergies from new partnerships can help improve the company’s bottom line in the future. (Read More: Walgreen’s Focus On Lowering Internal Costs Will Help Improve Its Bottom Line)

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1. Walgreen’s (WAG) CEO Greg Wasson on Q4 2014 Results – Earnings Call Transcript, Seeking Alpha, September 30, 2014 [↩]