Walgreens Earnings Reflect Boots Merger, Strong U.S. Sales

walgreens-stockI admit that I had it wrong on drugstore stocks. I really thought these were going the way of now defunct Circuit City, as all they offered were retail products that could be easily found online. Apparently, the management of Walgreens Boots Alliance (NASDAQ: WBA) didn’t get the memo. They had to go out and diversify and save their business.
For those who are still in the dark, Walgreens did not buy part of a shoe company. Boots Alliance is a U.K.-based drugstore operation. Let’s look at the entire new company before jumping into the fiscal third-quarter Walgreens earnings report, released Thursday.
Walgreens sells what it did before: drugs, general merchandise, convenience and fresh foods, household items, personal care, photofinishing and beauty care products.  Its pharmacy division handles not only standard drugs, but specialty, infusion and respiratory drug services, mail service, convenient care clinics and wellness centers.
Its “Our Take Care Health Systems” subsidiary manages in-store convenient care clinics. This is a really great idea that I had hoped the company would expand on. Instead, it sold off a controlling interest in the business. It now has 400 locations throughout the United States.  I like the model because it offers simple health care solutions for basic needs.

International Move

In 2012, the company bought 45% of Alliance Boots. Besides giving Walgreens international exposure, it also owns part of Alliance’s pharmaceutical wholesaling and distribution business. Walgreens subsequently bought the rest of Alliance.
Walgreens has a great U.S. footprint,with 76% of the U.S. population living within five miles of a store, resulting in 6.2 million daily visits. It also has had a robust online business, not only through Walgreens.com but through Drugstore.com.
The combined entity is doing very well. Walgreens said yesterday that its third quarter net income totaled $1.3 billion or $1.18 per share. Net income for the quarter was up 82%, and on an EPS basis, up 59%. This came on a sales increase of 48% to $28.8 billion.

Third-Quarter Performance

Let’s drill down into the segments to see if there’s any weakness.
The U.S. retail pharmacy segment generated the most revenue in the third quarter, at $20.4 billion, which was a 5.3% increase over last year. The more important number here is same-store sales, which came in at 6.3%. That’s a strong number.
Within this division, pharmacy sales really knocked it out of the park, with sales up 7%, but 9.1% on a same-store sales basis. That kind of high-single-digit growth is phenomenal. Given that pharmacy sales account for two-thirds of this division, it bodes well.
Walgreens’ international retail pharmacy segment came in with $3.3 billion in sales for the third quarter. Even after accounting for currency issues, due to the strong dollar, comps were still up 3.2%.
Its wholesale pharmaceutical business delivered record sales of $5.7 billion in the third quarter.
Walgreens is in excellent financial shape, with almost $4.5 billion of cash on hand against $15 billion in debt. The debt is large, but manageable due to the reasonable interest rate. Indeed, it is of little concern since operating cash flow was $4.16 billion and free cash flow was $1.58 billion. I see no problems with the debt load.

Bona Fide Growth Stock

So is Walgreens something that belongs in your portfolio, considering the strong quarter? The company did increase its EPS guidance to a range of $3.70 to $3.80 for FY15 and $4.25 to $4.60 for FY16, suggesting 15% to 20% EPS growth.
Analysts peg long-term annualized growth at 13.8%. Add in the 1.6% dividend, and Walgreen is a bona fide growth stock at 15.4% growth.
However, the stock is at $90, giving it a P/E ratio of 24, and a PEG ratio of 1.57.   I don’t mind paying more than a 1.0 PEG on a growth stock because the PEG ratio is more a measure for value stocks. However, Walgreens is pricey here. I would wait for a pullback to around $70 to consider it.

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