Walgreens Comfortably Beats Q3 Bottom Line Expectations, Cost Control To Be A Key Focus Area

Walgreens (NASDAQ:WBA) released its Q3 2015 results on Thursday, July 9 and comfortably beat expectations as it generated earnings per share of $1.18 per diluted share versus  $0.74 in the same period a year ago. (Fiscal years end with August.) The company’s top line benefited from continued growth in Medicare Part D scripts and a 20 basis point increase in its retail prescription market share. The primary contributor to the spike in earnings, however, is the strong progress that the company made in controlling SG&A expenses, including benefits associated with the cost savings program.

For the rest of the fiscal year, Walgreens will continue to maintain a rigid control on capital expenditure as it focuses on improving operating efficiencies to battle margin pressures. Another move that the company made that will help improve margins is the acquisition of British beauty company, Liz Earle. As retail sales yield higher margins compared to pharmacy sales, this acquisition will be a positive for the company’s overall margins.

Our current price estimate for Walgreens stands at $70, which is at a discount of about 20% to the market price.

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Cost Control And Working Capital Reductions To Be Key Focus Areas

As part of its cost savings program, Walgreens planned to close approximately 200 U.S. stores. In the previous quarter, nine stores were closed and approximately 70 to 80 additional stores will be closed by the end of the fiscal year (August). The company has also reduced IT costs in the US and announced a reduction of approximately 700 non store-based roles outside the US .

Walgreens will remain focused on generating cash through working capital efficiencies. Inventory management is one focus area where the company already made progress in the previous quarter. Walgreens improved its inventory days of supply in the U.S. by approximately six days versus the same period a year ago and the management sees further opportunities for working capital improvements. In a phase defined by major cost cuts and capital expenditure control, these reductions in working capital expenditure will unlock the much needed additional capital for necessary investments.

On Track To Achieve Goal of $1 Billion In Synergies

Walgreens is very much on track to achieve its target this year of $1 billion in quantifiable synergies, according to the company’s CFO George Fairweather. But, now that Walgreens is a merged organization (with Alliance Boots), the company is also starting to see other areas of best practice and ideas that they are implementing. As these benefits cannot be accurately measured, they have not been included in the expected synergy benefits.

One of the major benefits that the company realized from this acquisition is the higher bargaining power with drug manufacturers. However, major consolidation in the PBM industry has somewhat leveled the playing field again. For instance, from a total of about 100 companies in the PBM market in 2008, it has come down to just three companies controlling almost three-fourths of the market.

Commenting on this trend, which could result in future margin pressures, CEO Stefano Pessina said that the company is actively looking around, not just in the U.S. but even in other countries, for partners that could improve the value of the company. For the same reason, speculations have been around about Rite Aid being a potential acquisition target for Walgreens.

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Sources: Seeking Alpha