Saturday, January 19, 2013

Walgreen Still Looks Good Value

The JP Morgan Healthcare conference is the most important event on the industry's calendar and helps set the tone for the rest of the investing year. Typically the pharma/biotech companies outline the key pipeline events of the year or how they plan to expand existing product sales while the medical technology and services companies discuss their prospects for the coming year. I thought I’d help investors compress their research of the event and the sector by providing a brief overview of some of the presentations. In this article I want to look at Walgreen (NYSE: WAG).

Walgreen’s Growth Plans

I hold the stock and have written a recent overview of the company in an article linked here. That article gives a broad overview of the stock. I want to focus on some of the details recently discussed on how Walgreen is adjusting to the strategic and demographic landscape and planning for growth.

In the previous article I suggested that Walgreen had prospects from four main areas:

  • Winning back lost customers from the Express Scripts (NASDAQ: ESRX) debacle
  • Generics and in store sales will help increase margins and profits
  • The Alliance boots alliance will create earnings growth synergies
  • Expansion of its role in the local community

I’ll deal with these points in my commentary.

Walgreen in the Community

The last of these factors is the easiest to argue. Superficially it sounds like the typical PR friendly spiel that companies put out in order to keep up with the zeitgeist of trying to appear to be socially aware. However, this isn’t just about that, this is a coordinated plan to expand revenues via offering more services to a population whose health requirements are migrating towards what Walgreen can offer. I'll explain.

Walgreen has over 8,400 points of care in the US, including pharmacies, clinics and on site hospital presences. It claims to be located within three miles of 63% of Americans with a particularly high proximity to ethnic minorities. This gives Walgreen the opportunity to expand its services in areas like immunizations. Over five million flu shots were provided by Walgreen this year, and this is almost an ‘entry level’ service which encourages its customers to use Walgreen for other immunizations. It is working. Walgreen reported that revenues from its non-flu immunizations were up 100% last year.

Moreover, being local also gives Walgreen the chance to offer specialized clinics to offer ongoing help for people with growing diseases like HIV/Aids or diabetes. Theses indications take years of treatment and can represent strong long term cash flow generators for Walgreen. In addition, aging demographics will spur growth as older people require more prescriptions. Quite often these older people are moving from acute to chronic health care needs and Walgreen is positioning itself to benefit from these trends.

Stop Worrying About Express Scripts

The market doesn’t seem able to stop focusing on the lost customers from Express Scripts, and indeed when CVS Caremark (NYSE: CVS), Rite-Aid (NYSE: RAD) or Wal-Mart (NYSE: WMT) give commentary it is usually associated with optimistic pronouncements over keeping these customers.  They stop short of openly expressing schadenfreude at Walgreen’s woes but they also appear confident. For the record I happen to think they will keep many of them (because inertia is a powerful force) but this doesn’t mean that Walgreen’s stock isn’t cheaply priced!

Looking at industry trends, Rite Aid remains a small player. CVS is a strong company but its stock price looks up with events plus it has a bit more long term risk from its pharmacy benefit manager (PBM) operations. PBMs are not everyone’s favorite business (Walgreen exited the business a few years ago) and can be subject to political risk as well as the likes of Wal-Mart who are believed to harbor ambitions to try to bypass them.

Walgreen may have lost customers but it has also added 45 million customers to its loyalty program since Sept. 15, the idea being that the program can generate the data and CRM facility to allow Walgreen to expand its understanding of its customer base and then sell more services into it. Considering the favorable demographic and healthcare trends discussed in the previous paragraph this aspect of its operations fits nicely into Walgreen’s community plans.

Alliance Boots & Walgreen

In many ways Alliance Boots is Walgreen’s European doppelganger and its investment in the British company should not be seen as an ersatz investment. It may not be a majority share and there are reporting difficulties with it, but the two businesses are complimentary from a geographical perspective. Moreover, Alliance boots has substantive distribution facilities (Alliance is a leading wholesaler) and the knowhow and experience to develop products (Boots has substantive own brand labels) with which Walgreen can benefit from.

Many analysts questioned the deal at the time but then many did the same thing when McDonald's invested in Pret-a-Manger. However it seems that McDonald's learnt a lot from Pret, and its outlets are far less kitschy than they were before. Pret’s influence is clear (would there have been a McCafe if it wasn’t for the investment in Pret?) and I think Walgreen too will learn a lot from Alliance Boots.

Walgreen's Bottom Line

I think Walgreen is making the right moves, and it was interesting to hear how it is fleshing out its mid term growth plans. I think the stock has further to go and the sector is a strong one to be invested in. I am happy to hold with a $41 price target.

No comments:

Post a Comment