| Walgreen (WAG, NY) | |
| RESEARCH SUMMARY | |
| Report Author(s): | InvestorsFriend Inc. Analyst(s) |
| Author(s)' disclosure of share ownership: | Author(s) hold no shares |
| Based on financials from: | Aug '06 Y.E. |
| Last updated: | 6-Dec-06 |
| Share Price At Date of Last Update: | $43.56 |
| Currency: | $ U.S. |
| Current Rating (Company Rating does not consider the circumstances of any individual investor and is therefore not a recommendation and is not Investment Advice): | (lower) Buy rated at $43.56 |
| DESCRIPTION OF BUSINESS: Walgreens is a retail drugstore chain that sells prescriptions and non-prescription drugs and general merchandise. General merchandise includes beauty care, personal care, household items, candy, photofinishing, greeting cards, seasonal items. As of August 31, 2006, operated 5,461 stores (including 3 mail service facilities, 38 home care facilities, 18 clinic pharmacies, and 5 speciality pharmacies) located in 47 states and Puerto Rico. | |
| RATING: Based on the graph, Walgreen qualifies as a "great company" (and is cited as such in the book "From Good to Great."), with strong steady growth in revenue and earnings per share. In fact this is the 32cnd consecutive year of growth in both revenue and earnings! Walgreen passes all the Buffett Tenets, except the valuation one. Insider trading signal is neutral due to the selling in July of shares from options exercised. A negative to this business is that there could be continuing government regulations affecting margins in particular for generic and Medicaid related prescriptions. Competition from some of the larger chains, i.e. Wal-Mart, could cut into revenue and profits with their $4 generic prescription drugs. Walgreen has been a well managed company demonstrating good EPS and revenue growth and a prudent store growth strategy over the years. Based on the value ratios (strong steady growth and ROE but fully valued), good Buffett Tenets, attractive industry but negative implication of government regulations, we rate Walgreen a (lower) Buy. If you believe in the theory that winning companies tend to find a way to keep winning, then that would suggest this company will continue to do well. However, the shares would likely fall somewhat if earnings growth falls below about 12%. | |
| RISKS: The annual report provides a comprehensive list and discussion. The primary risks include highly competitive environment, reduction in third-party reimbursement levels could reduce margins, changes to government regulations, ability to hire staff, product liability issues, ability to find suitable locations, changes in economic conditions. | |
| INSIDER TRADING / INSIDER HOLDING: According to Vickers to Dec 01, 2006 there have been a large number of buys resulting from stock options given as part of the compensation packages. Sales by a number of officers took place in July 2006, likely to take advantage of high stock price (around $50) and to diversify investment holdings. These type of sales are not unusual and we take this to be a neutral signal. | |
| WARREN BUFFETT's TENETS: (See Robert Hagstrom's book - The Warren Buffett Way) - simple to understand (pass), good recent profit history (pass), prospects for above average returns (pass), apparently candid ethical management (pass), a high ROE (pass), modest profits on sales , although perhaps high for the retail sector (marginal pass), a low debt ratio, with no debt (pass), little chance of permanent loss of capital (pass) probably low level of maintenance type capital spending required to maintain existing operations excluding growth (pass) but not clearly selling at a discount to intrinsic value (fail). | |
| MOST RECENT EARNINGS TREND: The graph of revenue and EPS show a steady increase in increasing revenue and a very nice increases in EPS. In fact, this is the 32 consecutive year of growth in earnings and revenue for Walgreen. The historic growth rate of about 15% continued in 2006. | |
| VALUE AND GROWTH RATIOS: At a recent price of $43.56, price to book is unattractive, in isolation, at 4.34, but may be justified by the high ROE and Price to Book is usually not as important a value ratio in a retail environment. Dividend yield is not very high 0.7%. The adjusted P/E is high at 25.3 but may be justified by the growth. Past five year average annual growth in earnings and revenue per share have been an impressive and steady 14.9% and 14.2% respectively. Intrinsic value is estimated at $28.64 to $43.04 using an assumed five year growth rat of 9 to 12% which may be too conservative. Has an attractive adjusted interim ROE of 17.4%. The value ratios indicate a very strong company which however appears about fully valued unless one assumes that the past 15% earnings growth can be maintained. These value ratios in isolation point to a hold or (lower) Buy. | |
| SUPPORTING RESEARCH AND ANALYSIS | |
| Symbol and Exchange: | WAG, New York |
| Currency: | Canadian $ |
| Category: | Growth |
| Contact: | Invester.relations@walgreen.com |
| Web-site: | www.walgreen.com |
| INCOME AND PRICE / EARNINGS RATIO ANALYSIS | |
| Latest four quarters annual sales $ millions: | $47,409.0 |
| Latest four quarters annual earnings $ millions: | $1,750.6 |
| P/E ratio based on latest four quarters earnings: | 25.4 |
| Latest four quarters annual earnings, adjusted, $ millions: | $1,755.2 |
| BASIS OR SOURCE OF ADJUSTED EARNINGS: deduct pre-tax litigation settlement gains as follows: 2006 ($7.3 million) 2005 ($26.3 million) 2004 ($16.3 million), also add back in $42.4 million in 2005 for pre tax expenses related to the Hurricane Katrina. | |
| Quality of Earnings Measurement and Persistence: Earnings quality and persistence are good because earnings are in cash and consistent growth for 32 consecutive years. Walgreen is a drugstore so it would be more difficult to manipulate earnings, and the inventories largely have expiry dates so not likely to be stale. | |
| P/E ratio based on latest four quarters earnings, adjusted | 25.3 |
| Latest fiscal year annual earnings: | $1,750.6 |
| P/E ratio based on latest fiscal year earnings: | 25.4 |
| Fiscal earnings adjusted: | $1,755.2 |
| P/E ratio for fiscal earnings adjusted: | 25.3 |
| Latest four quarters profit as percent of sales | 3.7% |
| Dividend Yield: | 0.7% |
| Price / Sales Ratio | 0.94 |
| BALANCE SHEET ITEMS | |
| Price to (diluted) book value ratio: | 4.34 |
| Quality of Net Assets and Book Value Measurement: Quality of assets are excellent due to them being primarily cash, marketable securities, inventories and property and equipment with only a small amount of goodwill (approximately $434 million). | |
| Number of Diluted common shares in millions: | 1,007.9 |
| Controlling Shareholder: There is no controlling shareholder with the largest shareholder, Capital Research and Management Corporation, owning 6.835%. | |
| Market Equity Capitalization (Value) $ millions: | $43,902.5 |
| Percentage of assets supported by common equity: (remainder is debt or other liabilities) | 59% |
| Interest-bearing debt as a percentage of common equity | 0% |
| Current assets / current liabilities: | 1.7 |
| Liquidity and capital structure: Highly liquid with no long term debt, positive cash flow used to fund expansion. | |
| RETURN ON EQUITY AND ON MARKET VALUE | |
| Latest four quarters adjusted (if applicable) net income return on average equity: | 17.4% |
| Latest fiscal year adjusted (if applicable) net income return on average equity: | 18.5% |
| Adjusted (if applicable) latest four quarters return on market capitalization: | 4.0% |
| GROWTH RATIOS, OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE | |
| 5 years compounded growth in sales/share | 14.2% |
| Volatility of sales growth per share: | Revenue per share has been growing at a steady pace for the past 32 years.. |
| 5 Years compounded growth in earnings/share | 14.8% |
| 5 years compounded growth in adjusted earnings per share | 14.9% |
| Volatility of earnings growth: | Earnings per share have been growing at 14.9% for the past five years and growing for the past 32 consecutive years. |
| Projected current year earnings $millions: | not available |
| Projected price to earnings ratio: | not available |
| Over the last five years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in earnings per share? | Yes |
| Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained: | 15.2% |
| More conservative estimate of compounded growth in earnings per share over the forecast period: | 9.0% |
| More optimistic estimate of compounded growth in earnings per share over the forecast period: | 12.0% |
| OUTLOOK FOR BUSINESS: The overall outlook for business is positive with the ageing population that have a greater need for drugs in their older years. The general population is affected with an alarming increase in obesity, which can lead to diabetes and other conditions requiring greater use of drugs. These positives in expected drug sales, are offset by the Deficit Reduction Act of 2005 becoming effective in 2007, that will reduce the margins on generic drugs. The recent elections in the US, where the Democrats have won majority in both houses, may result in proposed legislation that will undermine future profitability for Walgreens. The competitive landscape may increase with Wal-Mart introducing $4 generic drug prescriptions which may reduce sales/margins. | |
| Estimated present value per share: We calculate $28.64 if adjusted earnings per share grow for 5 years at the more conservative rate of 9% and the shares can then be sold at a P/E of 15 and $43.04 if adjusted earnings per share grow at the more optimistic rate of 12% for 5 years and the shares can then be sold at a P/E of 20. Both estimates use an 8% required rate of return. | |
| ADDITIONAL COMMENTS | |
| INDUSTRY ATTRACTIVENESS: (These comments reflect the industry rather than any particular company.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition. barriers to entry (pass, difficult to create a national brand). issues with powerful suppliers (pass). issues with dependence on powerful customers (marginal pass, subject to third party insurance providers and federal medicaid), potential for substitute products (marginal pass, generic drugs provide lower margins) tendency to compete ruinously on price (pass). Overall this industry appears to be positive because of the aging population, generally requiring more drugs, and the alarming increase in obesity causing more diabetes and related illnesses requiring treatment. This is positive trend is offset by the new Democratic majority that may lead to additional regulation that may affect margins. Wal-Mart also announced a $4 charge on generic prescription drugs that may adversely affect returns. | |
| COMPETITIVE ADVANTAGE: With 5,461 stores located in 47 states and Puerto Rico, Walgreens is a nationally recognized drugstore. This broad coverage provides Walgreen with an advantage in contracting with third-party health insurance providers. Store locations are well selected and increasingly at standalone locations providing parking and easy access. Walgreen has developed well recognized private brands that now account for 17% of front-end sales and of course higher margins. | |
| RECENT EVENTS: Pharmacy margins decreased in part due to lower gross margins on Medicaid Part D prescription sales. The Deficit Reduction Act of 2005 becomes effective in 2007 and is expected to reduce margins on generic drugs. Expects to open 500 new stores. In 2006 purchased Happy Harry's Drugs (76 locations in Delaware) and three acquisitions in the managed care segment for a total of $485.4 million. | |
| ACCOUNTING AND DISCLOSURE ISSUES: Full and adequate disclosure. Walgreen did not implement the expensing of compensation by way of options until required to do so by accounting regulation, which is disappointing. Additional information as it relates to segmented product sales information would be useful. | |
| COMMON SHARE STRUCTURE USED: One share one vote. | |
| MANAGEMENT QUALITY: Experienced senior management who have been with Walgreen and their present positions over six years. Many executives in their forties, so succession planning not at issue. Management has implemented a growth strategy for the past 32 consecutive years of increasing revenues and earnings. | |
| EXECUTIVE COMPENSATION: Reasonable for a company of its scale. | |
| BOARD OF DIRECTORS: There are 11 board members, nine of whom are independent. The Chief Executive Officer and the President and Chief Operating Officer are also on the Board. | |
| Basis and Limitations of Analysis: The following applies to all the companies rated. Conclusions are based largely on achieved earnings, balance sheet strength, earnings growth trend and industry attractiveness. We undertake a relatively detailed analysis of the published financial statements including growth per share trends and our general view of the industry attractiveness and the company's growth prospects. Despite this diligence our analysis is subject to limitations including the following examples. We have not met with management or discussed the long term earnings growth prospects with management. We have not reviewed all press releases. We typically have no special expertise or knowledge of the industry. | |
| DISCLAIMER: All stock ratings presented are "generic" in nature and do not take into account the unique circumstances and risk tolerance of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. InvestorsFriend Inc. itself does not have a position in any of the indicated securities while the authors may have a position. | |
| © Copyright: InvestorsFriend Inc. 1999 - 2006 All rights to format and content are reserved. | |