Stock Thoughts: Walgreen Co. (WAG)
December 9th, 2007 by Grant in: Investing, Stock ThoughtsBack in October, I started looking for the next buy-it and forget-it stock. My initial thoughts were Southern Copper (PCU: chart, web, Y!) and Schering-Plough (SGP: chart, web, Y!). However, through comments on that post, Mike chimed in and mentioned Walgreen Co. (WAG: chart, web, Y!).
At the time Mike mentioned the stock, it was around $39 per share, and has since dropped a bit more and is starting to show signs of increasing value. I must disclose that Mike says he is a pharmacist and individual investor, and worked for almost all of the chain pharmacies (like Walgreens).
Financial Summary
The stock has a 3-month average volume of 9.2 million shares traded per day with a current market cap of $36.8 billion. The company is paying a $0.095 per share dividend on a quarterly basis, which translates into a 1% annual yield.
The price to earnings ratio (P/E) is 18.3 as of the writing of this post, which is a significant discount to the rest of the companies in the sector. The average P/E ratio in the sector is 29.82.
Earnings growth is 18.6 as compared to a 21.41 average for the sector.
Earnings per share (EPS) is $2.03 and continues to increase quarter to quarter.
A few quick facts about the company…
- Walgreen Co. was incorporated as an Illinois corporation in 1909 as a successor to a business founded in 1901. Walgreens is the nation’s largest drugstore chain (based on sales) and recorded its 33rd year of consecutive sales and earnings growth. During the year, the company opened or acquired 563 stores for a net increase of 478 stores after relocations and closings, not including 58 locations acquired from Option Care, Inc. The total number of locations at August 31, 2007 was 5,997 located in 48 states and Puerto Rico. Aggressive growth will continue as the company anticipates operating more than 7,000 locations in 2010.
- During fiscal 2007, Walgreens’ market share in 59 of the top 60 front-end categories increased, as compared to all food, drug and mass merchandise competitors. Today, 139.1 million people live within two miles of a Walgreens and 5.0 million shoppers walk into a Walgreens store daily.
- Walgreens pharmacy sales are expected to continue to grow due, in part, to the aging population, the introduction of lower priced generics and the continued development of innovative drugs that improve quality of life and control healthcare costs. Also, the increase in generic introductions continues to boost the number of prescriptions filled. Although generics reduce sales dollars, they save both patients and payors money and generally offer higher gross profit than brand name drugs.
- Prescription sales continue to become a larger portion of the company’s business. This year prescriptions accounted for 65.0% of sales compared to 64.3% last year. Third party sales, where reimbursement is received from managed care organizations, government and private insurance, were 94.8% of prescription sales compared to 93.1% a year ago. Overall, Walgreens filled approximately 583 million prescriptions in 2007, an increase of 10% from the previous year.
Financial Trends
In 2007 the company reported its 33rd straight year of record sales and earnings growth. Sales rose 13% to $53.8 billion, and earnings before interest and taxes grew by 17%, to $3.2 billion. Sales of lower priced generic drugs are increasing, which means sales growth may be lower than the five-year annual growth rate of 15%.
There is a shift happening from general merchandise to pharmacy drugs, which means that margins may not be all that great (traditionally there is larger margin in merchandise than in name brand prescription drugs). However, this trend may be offset by the increase in generic drugs, in which there is a wider margin.
The companies debt-to-equity ratio is very low at 0.11 and is lower than the industry average. This indicates to me that the company does a good job of managing debt.
Insider Activity
The Walgreen insider roster is fairly extensive with a list of 32 officers or directors. Lately, there has been a slew of insider acquisitions on the non-open market by nearly all of the listed insiders. This appears to be a function of executive stock rights at the end of the fiscal year. However, it should be noted that very few of these shares have been sold since the acquisition.
The Corner Office Thoughts
While Walgreen is starting to show signs of life after a significant sell-off, it will take at least another quarter to determine whether they’re back on the upswing or still struggling to increase growth.
EPS continues to increase each quarter, but the rate is starting to decline. The company has a great track record on increasing sales, which makes for a good buy-it and forget-it stock.
Overall, the company is not as healthy as it’s peers in the sector, and I suspect that the transition from majority sales in high-margin merchandise to lower margin name-brand drugs will not help. On the flip side, an aging population will only increase demand for pharmaceuticals, and wider-margin generic drugs will help offset decreasing sales in merchandise.
At this point in time, Walgreen looks like more of a gamble than I want to take. Some would say that you should buy a stock when it’s fallen, like WAG has, but I would say the time to buy a stock is after it has fallen, and is on it’s way back up. I have no problem leaving buying late with the comfort of knowing things are looking up.
Additional Resources
Tags: drug | pharmaceuticals | Stock Thoughts | WAG | Walgreens
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December 9th, 2007 at 6:20 pm
I agree with you on your take of WAG. I agree that the generic business will continue to capture more and more market share. I also think consumer spending will not be as strong as it has been. So, that being said, I’d make a direct play on generics and look at something like NVS or TEVA. I’m long BMY for drug exposure, but the thing I don’t like is the fact I believe generics will continue to chip away at big pharm.
One of my ‘buy and forget about it’ stocks is ADM. If the bull market in commodities is still intact, which I believe it is, than ADM is wildly undervalued in my opinion. Sure, they have a lot of exposure to ethanol, but they are also one of the biggest overall grain processors. And, if the Democrats take over the White House than a lot of these alternative energy initiatives should continue to attract cash, which ADM is properly positioned.
December 9th, 2007 at 8:07 pm
Winston, why don’t you hedge your Bristol-Meyers with Teva?
Why do you see ADM as undervalued?
December 9th, 2007 at 10:29 pm
I’ll either be buying Teva or Novartis this week.
My reasons for ADM center around food and alternative energy:
Reason 1: China. Maslow’s hierarchy of needs state that people first must satisfy their ‘deficiency’ needs, i.e. shelter and FOOD. China’s GDP is growing and city centers are expanding outwards. My point is that the Chinese will be increasingly buying and consumer processed foods rather than consuming what they grow themselves. The demand for processed food will grow and ADM is first and foremost a commodities processor….processing ’stuff’ into viable food inputs.
Reason 2: Further on China, there are 8 million non-governmental cars in China versus 120 million in the US and China has 5x the population. Point is that the push for alternative energies will continue and is not a fad.
Reason 3: the stock soared when corn prices continued to push higher and higher because of the ethanol craze. Now corn prices reflect the fact that farmers have planted/harvested an unprecedented amount of corn. This makes the ethanol input less expensive equaling margins that are more attractive, at least more attractive than before. Ethanol may not be the best alternative to crude (energy output-wise), but the fact is that it’s being made and ADM is a big processor without having dircet 100% exposure to ethanol.
I’m averaged in ADM at just under $33 and I plan on averaging up…
December 9th, 2007 at 10:38 pm
Excellent explanation. Thanks Winston.
December 11th, 2007 at 1:31 pm
Grant,
Two that look pretty good…
FDX, although it is a little late when it was a super value at $92/share and below. It is a well run company turning a profit and just increased prices on shipping to get things more in line with UPS. Shipping occurs in all types of economies and if say oil prices lower back down some, the profit should be that much higher.
PBD, an ETF that is covering the best of the best of Alternative Technologies companies. I has worldwide holdings of the best wind and solar makers and energy companies. If you think wind is the next big thing, this will be a really good play. Check it out.
I can go into more detail on both if you would like, just don’t have the time right now…
Great blog though…
December 11th, 2007 at 6:42 pm
Matt, how do you think the likes of FDX and UPS stand up to their railroad counterparts?
I’m not sure wind is the next big thing. I think it will follow suit with nuclear energy in that people love the idea, they just don’t want a wind turbine in their back yard. The difference is that there are more wide-open locations for wind turbines than nuke plants, which is where wind has an advantage…
December 11th, 2007 at 8:49 pm
I own NSX which was my favorite railroad pick before Buffett hopped into the market (I also bought it just before that occured). Norfolk Southern is the most efficient of the group, they are the most automated, and can adjust to the market quickly.
UPS and Fedex aren’t really in the same market as railroads and trucking freights. They actually have a niche. Fedex has great prices in the small to medium package sizes, UPS in the medium to large prices. UPS, I guess at times does compete during large freight, but Fedex typically does not. USPS is a bigger competitor. Regardless Fedex like NSX is highly efficient, highly automated, and has good prices…the stock itself is at a pretty good price right now. The online market is using Fedex and UPS to deliver goods to peoples homes, this won’t go away either.
By the by, wind is only big in a few spots in the US, google wind turbine manufacturing in Iowa and you will see several new facilities being built to help support new wind farms in the US. Kansas is just starting to really build wind farms, and I think Minnesota is starting to get in the mix. Iowa, California, and Texas is huge into wind farms, it is only a matter of time before others follow suite. Also which is going to be approved more quickly for new power a wind farm or a nuclear power plant?
But I digress…PBD is the made up of the best of the best around the world! SPWR, FSLR, STP are good stocks (and overpriced now) but the best solar and wind companies come from spain, germany, and more unique european locals. It may be the last great alternative stock to play today.
December 11th, 2007 at 9:07 pm
I meant alternative move not stock since this is an ETF…sorry.
December 11th, 2007 at 11:27 pm
Dang, I hadn’t thought about the international aspect to the wind turbine industry. This could help hedge the dollar and the US economy, not to mention oil.
I suppose it stands to reason that UPS/FDX hold a different market when it comes to shipping and freight than the railroads do. Perhaps a railroad stock would be a good hedge against fuel prices and the trucking industry… what do you think?
December 12th, 2007 at 1:27 am
Good post Grant..
I’m curious though to what you consider Walgreens peers? When you say it’s not as healthy as it’s peers in its sector, I’d have to disagree. Sometimes analysts tend to include competitors that aren’t “really” competitors. There is no other retail drug chain that is as financially healthy as Walgreens.
Some other trivia about WAG:
1. They open a new stand-alone drug store (without long-term debt) every day. That’s quite an accomplishment.
2. Walgreens.com is the nation’s most heavily trafficked internet pharmacy website. It was also ranked by HealthRatings.org as number one in ease of use and quality of information.
3. Walgreens is moving into the urgent care business in a big way by opening clinics inside their drugstores. This will increase diversification, provide patient convenience, and improve it’s bottom line. People love the low cost and convenience of these urgent care clinics. They can find all of their healthcare needs in one place, without the 12 hour waits experienced in emergency rooms.
December 12th, 2007 at 10:27 am
To answer your question, yes it is a good alternative to trucking and gas stocks. When prices of oil increase greatly it will hurt those trucking companies and will make railroad shipment more cost effective. But the overall affect may be that less consumerism may occur and less items may need shipment as well, so the risk is that oil, trucking, and railroad may all get hurt. I am pretty unsure how it will shake out.
Looks like it may be a bad buying day, everything is up. Oh yeah, WAG seems pretty good as well, between Mike and yourself explaining it all out, I may be looking to buy in.
December 12th, 2007 at 9:34 pm
Hey Mike,
I’d consider CVS a peer to WAG, and by the pure technical valuations, they are slightly ahead of WAG in terms of P/E, market cap, and all the other “measuring sticks” that really don’t do a good job of valuing a stock.
I would agree to a certain extent that WAG may be more financially sound, and they certainly have more exposure to the market, at least in my area.
How do you think the shift from name-brand to generic drugs will play out?
I like the fact that WAG is opening urgent care facilities, but I have to wonder if this will be a widely accepted alternative to going to a hospital. I see this as a capital intensive idea, that may reap huge rewards, but if it’s not accepted, it’ll go bust quickly.
-Matt, let us know how your WAG play goes.
At this point, I’m going to sit on the sidelines and see how this market fluctuation plays out towards the end of the week.
-Grant
December 12th, 2007 at 10:53 pm
[…] our good buddy Winston mentioned a few stock ideas in a discussion about Walgreens. He mentioned that Archer Daniels-Midland (ADM: chart, web, Y!) was his buy-it and forget-stock. So […]
December 13th, 2007 at 11:49 am
I would agree that CVS is Walgreens biggest competitor, and it’s merger with Caremark was a great move. This ONE business move by CVS should cause concern for WAG. IMO, WAG has the better business model, management and organizational skills though.
IMO, these two will be the last surviving publicly-traded drug retailers in the future. However, be prepared to see all the merger and integration costs to affect CVS fundamentals soon. They may look good now but that won’t last long.
The switch from name brand to generic drug is all market hype, retail wise. It may have some affect on pharmaceutical manufacturers, but it won’t affect retailers significantly. The new government reimbursement rates (medicare part-D) will affect drug retailers more than anything.
As you written yourself, 3rd-party plans dictate prescription reimbursement (94.8%) rates. The bigger the company, the more power it has to negotiate better rates. However, ALL drug retailers make better profits from generic drugs, whose profits vary by the ability (company size) to negotiate better acquisition prices. With all of the generic competition, generics can be bought cheaply.
As an aside, I was recommending Option Care years ago when it traded in the single digits. I wish I’d held onto it.
About urgent care facilities.. CVS is opening theirs too. Are they a widely accepted alternative to hospital ERs?
For the uninsured, I’d have to say a BIG NO. ERs can’t turn people away regardless of their ability to pay or not.
For others, a BIG YES. Of course, there are times when folks must visit the ER or be admitted to a hospital. However, many people use ERs as their primary care providers. Most folks, including me, don’t have a family doctor.
In many (most?) cases, people are visiting the ER with complaints that can easily resolved at an urgent care clinic (URI, cough/cold/flu symptoms, UTI, aches/pains, cuts and abrasions, conjunctivitis, etc.). I know for sure that in my area, 12-hour ER waits are not uncommon.
Most urgent care centers will usually see you right away or in an hour or less. As a pharmacist, I’ve recommended nearby urgent care centers when people come in with complaints I believe need referral. Most have come back, happy with the service, and to thank me for the referral (and usually fill a prescription).
Why wouldn’t they use an urgent care center? They only had to pay a copay, got seen quickly, and NOW can get any prescriptions filled without having to drive anywhere else in their sickened condition. Moms especially love this convenience.
Again, 3rd-party plans dictate which doctor they will pay for… in essence dictating who you can see. WAG (and CVS too) urgent care centers will accept the vast majority of healthcare plans.
December 13th, 2007 at 10:48 pm
Hey Matt, you might hold off on your WAG decision until after the Q1 conference call on the 21st…
December 20th, 2007 at 3:09 am
I would like to see a continuation of the topic