Walgreen Reports A Solid Q1’15, Is Confident Of Carrying On The Growth Momentum Through Fiscal 2015

The largest drugstore chain in the U.S, Walgreen (NYSE:WAG) made a solid start to fiscal 2015 with a 6.7% increase in its Q1 2015 revenue ($19.6 billion). Continued growth in the daily living business and prescription volumes and a strong holiday season contributed to a strong comparable store script growth of 4.1% (year-on-year) in the quarter. As expected, Walgreen continued to face downward pressure on gross margin, which declined by 1 percentage point from the year ago period, as the higher retail margin failed to offset the decline in pharmacy gross margin. Nevertheless, a largely fixed cost structure and prudent SG&A spending improved the company’s net income by 18.8% year on year. GAAP operating income for Q1 2015 was $991 million, up 7.1% from $924 million last year.

Although Walgreen believes that gross margin pressure will persist in the short-term, the company is confident 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 in new generics and growing demand for a personalized healthcare  experience.

Our price estimate of $64 for Walgreens is approximately 15% lower than the current price estimate. We are in the process of updating our model for the Q1 2015 earnings.

View our analysis for Walgreens

Walgreen – Alliance Boots Transaction To  Close By December End

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 into new markets including Europe, China, Latin America, etc. It achieved $154 million in combined net synergies with Alliance Boots in fiscal 2013. Cost synergies for Q1 2015 totaled $140 million and adjusted EPS accretion from investment was $0.11. Walgreen claims that the progress it is making with synergies is slightly ahead of schedule and there could be an upside to its $650 million goal for the fiscal year.

In November 2014, Walgreen secured financing to close the transaction, as well as refinance the majority of Alliance Boots outstanding debt. Pending shareholder approval, it expects the transaction to close on December 31.

By 2016, Walgreen aims to achieve the following four goals:  1) sales of $130 billion, including Alliance Boots share, as well as associates and joint venture sales; 2) synergies of $1 billion; 3) operating cash flow of $8 billion; and, 4) net debt of $11 billion.

Walgreen Continued To Gain Share In The Retail Pharmacy Market In 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. In Q1 2015, the company’s total prescription sales grew 9% and it retained its retail market share at 19%. In Q1 2015, the company grew scripts by 10 basis points more than the rest of the retail industry, according to IMS data. ^[1]

The continued focus on winning and gaining share with high value seniors, through preferred relationships with Medicare Part D plans, helped drive growth in comparable same-store-sales. Since 2013, Walgreen’s 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. While this business carries lower margins than the rest of the script business, Walgreen claims that it drives incremental revenue and gross profit dollars.

Focus On Lowering Internal Costs To Improve Bottom Line

While Walgreen marked its third consecutive quarter of year-on-year improvement in retail products gross margin, its pharmacy gross margin continued to face margin pressure, due to third party reimbursement pressure from contract step downs, ongoing generic drug inflation on a subset of generic drugs, and increased mix of specialty drugs. Partially offsetting these pharmacy margin decreases were the positive effects of a step up in the introduction of new generics this quarter and purchasing synergies generated by the joint purchasing group.

The company expects the negative factors impacting pharmacy margin to intensify in Q2 2015 as the impact from a meaningful step down in Medicare Part D rates begins January 1st. Walgreen remains focused on mitigating the impact of these negative factors through a number of mechanisms including leveraging its buying group to secure better costs for drugs, incorporating inflation protection in payer contracts as they come up for renewal, and continuing to help align appropriate industry reimbursement levels. It believes that the retail products will continue to drive gross profit dollar growth. Additionally, Walgreen is focusing on keeping its gross profit dollar growth rate higher than its SG&A dollar growth by greater than 100 basis points.

The key elements of its strategy to counter the downward pressure on gross margin are:   1) to focus on enhancing its mix towards more upscale retail products to drive higher margins; 2) to drive supply chain efficiencies by removing excess costs and thereby improving overall store productivity; and, 3) to leverage its Balance Rewards loyalty program to derive valuable insights which will help the company better target its promotional investments.

Walgreen claims to be on track to achieve the $1 billion in cost savings reflected in its fiscal year 2016 goals.

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1. Walgreen’s (WAG) CEO Greg Wasson on Q1 2015 Results – Earnings Call Transcript, Seeking Alpha, December 23, 2014 [↩]