Walgreen (WAG) reported an EPS of 80 cents in the second quarter of fiscal 2011, meeting the Zacks Consensus Estimate and higher than the year-ago quarter’s 68 cents. However, results for the quarter included a penny each for both restructuring cost and integration costs associated with the Duane Reade acquisition. The second quarter in fiscal 2010 included 2 cents per share towards restructuring costs.
The company reported $18.5 billion of total sales for the second quarter, up 8.9% from $16.9 billion in the year-ago period. While comparable store sales (those open for more than a year) during the quarter increased 4.1%, front-end comparable drugstore sales increased 4.3%. Prescription sales, accounting for 62.6% of sales in the quarter, increased 7.7%, while prescription sales in comparable stores increased by 3.9%. Moreover, the company also increased its retail pharmacy market share to 20.1%.
Gross margin for the quarter at 28.8% remained unchanged from the year-ago quarter. While front-end margins benefited from the cough/cold and flu season as well as holiday season performance, pharmacy margins remained constant. Selling, general and administrative expenses during the quarter increased 8% year over year to reach $4.1 million primarily driven by Duane Reade’s acquisition-related costs and new store openings, slightly offset by lower restructuring costs.
Walgreen generated $886 million in cash flow from operations during the quarter and $2.1 billion for the first half of fiscal 2011. At the end of the quarter, the company had $2.2 billion in cash and cash equivalents, down from $2.5 billion at the end of February 2010.
In order to make the best use of available funds, Walgreen has scaled down its plan of opening stores. We believe this decision will benefit the company as the new stores take 2 to 3 years to break even and will conserve cash. The company expects an organic store growth of 2.5%−3% in fiscal 2011.
Our Recommendation
We are encouraged by Walgreen’s recent decision to sell its PBM business to enable it to better focus on its drugstores. Moreover, the benefits from CCR rollout and rewiring initiative will be experienced over a period of time.
Leveraging on its strong cash balance, the company is well equipped to pursue suitable acquisitions in future. However, Walgreen has been impacted over the past few quarters by high unemployment levels and lower discretionary spending.
We have a ‘Neutral’ recommendation on the stock, which also corresponds to a Zacks #3 Rank (hold) in the short-term.
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