Walgreen: Earnings Preview – Analyst Blog

Walgreen (WAG) is scheduled to report its second quarter results of fiscal 2010 on March 23, 2010. The Zacks Consensus Estimate for the quarter is pegged at a profit of 72 cents.

 

Going by past trends, Walgreen has surpassed expectations in the last two quarters. The company had a positive surprise of 8.33% and 12.82% in the first quarter of fiscal 2010 and fourth quarter of fiscal 2009, respectively, with a positive four-quarter average of 3.2%. This means that, on an average, the company has topped the Zacks Consensus Estimate by 3.2% over the last four quarters. If second quarter earnings meet our expectation, it will represent a growth of 4.3% over 69 cents reported in the second quarter of fiscal 2009.

 

Walgreen has taken several strategies to achieve double-digit growth by 2011. These include leveraging the existing store network, improving experience for shoppers and patients and targeting $1 billion of annual cost reductions by fiscal 2011.

 

As part of the first strategy, the company has scaled down the pace of store opening. We believe this decision will benefit the company in making the best use of its available resources as new stores take 2−3 years to become profitable.

 

In February 2010, Walgreen decided to acquire New York-based drugstore chain Duane Reade Holdings for a total enterprise value of $1.075 billion, including debt. Although the acquisition will expand its presence in the New York area, it will be dilutive to its earnings per share (EPS) in the first 12 months after closing and accretive in the next 12 months and thereafter. Walgreen expects to achieve synergies of $120−$130 million three years after closing the transaction.

 

Earnings revisions for the second quarter of 2010 had a clear negative bias. Over the past 30 days, 9 of the 18 analysts following the stock have lowered their estimates with no upward revisions. The same trend has been witnessed in the past 7 days with 2 analysts lowering their estimates. We believe the impact of the above mentioned acquisition is reflected in the estimate revisions.

 

For fiscal 2010, the current Zacks Consensus Estimate is $2.28. Of the 20 analysts covering the stock, 14 and 3 have downgraded their estimates over the last 30 and 7 days, respectively. No upward revision has taken place during the same period.

 

The scenario for 2011 is similar. Among 22 analysts covering the stock, 13 and 2 have downgraded their estimates over the past 30 and 7 days, respectively, without any upward revision.

 

Apart from the acquisition, which will dilute Walgreen’s EPS for the time being, other factors that might have played a role in the negative bias include lower growth in same store sales (those open for more than a year) and reduced margin.

 

Industry conditions remain challenging, as insurers reduce reimbursement rates and increase prescription co-payments. After experiencing robust same-store sales growth of 7.7% and 8.1% in fiscal 2006 and 2007 respectively, total sales in comparable stores increased just 4.9% during the first quarter of fiscal 2010.

 

Walgreen is experiencing a shift towards the pharmacy business, which carries lower margins than front-end merchandise. In fiscal 2008, the gross margin contracted 15 bps to 28.2% while the operating margin declined 14 bps to 22.4%. The trend has continued in fiscal 2009 as well, with the gross margin declining by 40 bps to 27.8% compared to the previous year.

 

 

We believe the company has performed quite well, especially with weak discretionary consumer spending due to the economic recession weighing on high margin front-end sales. We have a Neutral recommendation on the stock.