Walgreen Earnings Drop On Express Scripts Fallout But Outlook Is Solid

The U.S.’s largest drug retailer, Walgreen (NYSE:WAG), reported fourth quarter results on Friday, September 28th. Revenues were down 5% on the year to $17.1 billion from $17.9 billion. The company’s Express Scripts network impasse was the major contributor to the revenue drop. Operating income for the fourth quarter dropped 54% compared to same quarter in 2011 to $586 million. The income reflects the inventory-related charges and charges due to a multi-billion dollar investment in European health and beauty retailer Alliance Boots. The company currently operates 7,930 drugstores and competes with CVS Caremark (NYSE:CVS) and Rite Aid (NYSE:RAD) among others.

View our analysis for Walgreen

Impasse with Express Scripts has a minor impact on sales

Revenues for Q4 FY 2012 were down 5% to $17.1 billion compared to $17.9 billion last year. However, year on year sales dropped by just 0.8% to $71.6 billion. This was despite the company losing Express Scripts business which constituted 11% of total prescriptions it filled in 2011 FY. The company noted that the proliferation of generic drugs also had a negative impact on the sales which would otherwise be higher by approximately $1.4 billion.

Backed by the strong performance in FY 2012 and the renewed multi-year Express Scripts deal which came into effect mid-September, we expect the company to grow its revenues over the forecast period. The growth should be supported by its partnership with Alliance Boots which would drive its expansion in the international markets and the recently launched Balance Rewards program which would encourage repeat purchases even as it attracts back Express Scripts customers who had migrated over to other pharmacies.

Generic proliferation and cost control efforts limit the drop in earnings

The company reported fourth quarter net earnings of $353 million compared to $792 million in the previous year. Net income for the year was down nearly 22 percent to $2.13 billion. The FY 2011 and FY 2012 figures exclude proceeds from the sale of Walgreen’s Health Initiative and Alliance Boots transaction costs respectively. The drop in margins was limited by pharmacy margins which improved as a result of the new generic drugs. OTC drugs, household and personal care categories also contributed positively to the margins.

We expect the company’s earnings to grow from the current levels as it wins back Express Scripts customers over the coming period and as the costs associated the acquisition of 45% stake in Alliance Boots get accounted for. In an effort to mitigate the loss of the Express Scripts business, the company conducted cost interventions as a result of which SG&A costs grew by only 3.4% for the quarter versus 15.2% growth in the same quarter last year. These efforts will have long term effects and will help the company grow its margins.

We are currently in the process of revising our $39 Trefis price estimate for Walgreen.

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