Walgreen Reports Strong Q4’14 Sales But Gross Margin Remains Under Pressure

Walgreen (NYSE:WAG), the largest drugstore chain in the U.S., reported sales for the month of August and Q4 2014 (ended August 31) on September 4. At $6.39 billion, August sales increased 3.6% compared to the same month last year. Total sales for Q4 2014 were $19.06 billion, up 6.2% annually. Higher daily living sales, strong performance in prescriptions filled, and increasing pharmacy market share have all helped Walgreen post continuous improvement in its top line growth. Despite a soft macro environment, Walgreen reported healthy growth throughout fiscal 2014. Walgreen’s stock price increased almost 3.5% after the sales release.

While Walgreen’s top-line continues to grow, the company faces ongoing pressure on gross margins. The company expects its Q4 2014 gross margins to decline by a similar percentage (annually) as that witnessed in Q3 2014.

View our analysis for Walgreens

Quick Snapshot of August & Q4 2014 Sales

Comparable stores sales increased by 3.7% in August 2014. Generic drug introductions in the last 12 months negatively impacted total comparable sales by 1.2 percentage points. Total front-end sales increased 2.1% and comparable store front-end sales increased 1.4%. Though Walgreen saw a 1.7% decrease in customer traffic at comparable store, basket size increased 3.1%. Prescriptions filled at comparable stores grew by 1.1%. Pharmacy sales, which accounted for 65.7% of total sales for August, grew 5.4%. August 2014 had one additional Sunday and one fewer Thursday compared with August 2013.

For Q4 2014, Walgreen reported 5.6% and 1.3% growth in comparable store sales and front-end comparable store sales, respectively. Prescriptions filled at comparable stores increased 3.9% and comparable pharmacy sales grew 8.2%. Calendar 2014 year-to-date sales for the first eight months stand at $50.91 billion, 5.7% higher compared to the same period last year. Sales for fiscal 2014 total $76.43 billion, an annual increase of 5.8%.

Gross Margins Remain Under Pressure

Walgreen’s gross margins declined by 50 basis point, from 28.5% in Q3 2013 to 28.0% in Q3 2014. The company is seeing ongoing gross profit margin pressures, including generic drug inflation, reimbursement pressure and a shift in pharmacy mix toward 90-day prescription refills at retail locations and Medicare Part D. In addition to the above factors, the absence of net gains from a certain litigation matter in Q4 2014 will also impact gross margin growth (annual) in the quarter.

In the last few years, the U.S. market for medicines has shifted more towards generic drugs as a significant number of patents expired for major brand names. Generic drugs are comparatively lower priced but offer higher gross margins (approximately 50% higher) than branded drugs. However, in the last one year, Walgreen claims that the market has shifted from historical patterns of deflation in generic drug costs into inflation, a trend that is negatively impacting margins. The company has witnessed higher costs for a subset of generic drugs and in some cases the increase has been significant.

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. A key member of Walgreen’s executive team has been appointed to focus on increasing efficiencies and providing high quality and cost effective pharmacy services that reduce total pharmacy costs. Additionally, Walgreen expects the completion of the strategic transaction with Alliance Boots to drive sustainable efficiencies and value for the combined enterprise, offsetting the increase in drug pricing.

Our price estimate of $64 for Walgreens is slightly higher than the current market price.

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