Walgreen: WAG Stock Is a ‘Buy’ Despite So-So Earnings, Industry Headwinds

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Walgreen (WAG) shares got an early boost Tuesday after reporting mixed fourth-quarter and full fiscal 2014 earnings, but couldn’t keep the momentum going and finished slightly in the red.

Walgreen (NYSE:WAG)The pharmacy chain merely met Q4 earnings estimates of 74 cents per share on an adjusted basis — a respectable showing considering that WAG stock has fallen short of quarterly consensus estimates several times over the past couple years.

Tuesday’s struggles are symbolic of Walgreen’s broader issues — shares are up just 3% year-to-date to underperform the market, and 22% below June levels. Meanwhile, fierce industry headwinds have developed that will continue to blow for the foreseeable future.

Nonetheless, the retailer is on its way to realizing more than $1 billion in synergies with Alliance Boots, and the influence of Jana Partners on the board will keep cost cutting in the spotlight.

While conditions aren’t perfect for the retailer — or the industry, for that matter — shareholders may want to hunker down and ride out the storm with WAG. Here’s why:

Walgreen Earnings

Sales were a bright spot in the Walgreen earnings report — WAG saw quarterly net sales improve 6.2% to $19.1 billion, and fiscal 2014 sales increase by 5.8% to $76.4 billion. That’s the company’s strongest gains in three years.

Q4 revs were buoyed by a 9.3% jump in prescription sales, which boosted its retail pharmacy market share 30 basis points to 19%.

Investors got a glimpse of this momentum when the company in recent weeks reported a 3.6% sales increase for the month of August alone, although there has been little celebration of WAG stock in the interim.

Shareholders have been dismayed since Walgreen lowered its 2016 profit outlook in June.

Headwinds Outpace Tailwinds

Walgreen’s fundamentals are propped against the backdrop of some tough conditions in the pharmacy industry.

While WAG stock enjoys the tailwinds of an aging population, a higher number of Medicare Part D patients and prescription growth that’s outpacing that of the industry, it’s also up against lower reimbursement payments, Medicare Part D and generic-drug inflation, evidenced by a 90-basis-point drop in the pharmacy chain’s Q4 gross profit margin to 28%.

With no apparent relief in sight, these headwinds will be with Walgreen “for a while,” according to management on the earnings call. Worse, the headwinds are going to continue to outpace any tailwinds in fiscal 2015, leaving investors little optimism for any short-term relief.

However, WAG stock investors should note that the broader pharmacy sector is feeling pains from the healthcare industry, evidenced by Rite Aid (RAD) being forced in recent weeks to reduce its fiscal 2015 earnings guidance amid falling reimbursement rates and generic-drug inflation.

Shareholder Value

In keeping with its tradition, WAG in recently increased its dividend for the 39th consecutive year, keeping it on our list of Dependable Dividend Stocks.

However, investors continue to press WAG management about “incremental share buybacks,” according to Walgreen’s earnings call, in response to which executives said they would “continue to discuss capital allocation policies with the board and to make changes when appropriate to maximize shareholder value.”

Meanwhile, the company has an aggressive capex plan for fiscal 2015, during which time it plans to spend $1.7 billion compared to $1.1 billion in fiscal 2014 as a function of an anticipated opening of 1,000 new wellness-format stores this fiscal year, which should allow it compete more effectively with CVS Health (CVS).

Walgreen generated $2.8 billion in free cash flow in fiscal 2014, and execs aren’t expecting a material change to that in the current fiscal year, according to the earnings call.

Of course, the presence of Jana Partners on Walgreen’s board should bring investors some confidence about the way cash will be directed. After all, activist investors have had momentum this year, evidenced most recently by eBay’s (EBAY) decision to spin off its PayPal unit — a plan that was trumpeted by activist investor Carl Icahn.

In Walgreen’s case, the Jana board members are pushing for more aggressive cost cutting to unlock greater shareholder value, which is part of the offensive against generic-drug inflation and which has surfaced thus far in the way of a hiring freeze.

Conclusion

For WAG stock holders, patience will be key as the pharmacy chain continues to realize synergies with Alliance Boots and industry trends shift in its favor. Nonetheless, Walgreen is taking the arduous yet necessary steps to emerge stronger on the other side of the perfect storm.

Long-term investors should view any additional pullback in WAG stock as a buying opportunity because when the dust settles, shares are poised for a comeback.

As of this writing, Gerelyn Terzo did not hold a position in any of the aforementioned securities. 


Article printed from InvestorPlace Media, https://investorplace.com/2014/10/wag-stock-walgreen-earnings-buy/.

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