Weekly Stock Call

September 24, 2010
Current Price – US$29.51


Walgreen’s (WAG) business stands to benefit greatly from an aging demographic in the U.S. and the associated increased need for more and better prescription drugs. While the company does face stiff headwinds from government pressure to reduce pricing, it operates as a virtual oligopoly with competitor/partner CVS Caremark and should be able to resist significant erosion of its margins. Walgreen is principally a retail drugstore chain with over 7000 stores in the U.S. generating $63B in annual revenues (75% derived from the sale of drugs, the remainder from general merchandise). 

The company has achieved 36 consecutive years of revenue growth, is minimally dependent on debt and continues to return a growing dividend. Despite this, current share price seems to be significantly discounted based on analysis of historical valuation ratios and projected earnings.


Valuation

Based on a blend of valuation methods (discounted cash flows, dividend discount model and, historical and industry price ratios) I arrive at a current valuation for Walgreen Co. of US$36.14.

Expected return should this price be realized in the markets within the next 12 months would be:

Price yield       22.5%
Dividend yield   2.4%
Total return     24.8%


Risks

Listed below are some of the immediate risks faced by the company. For a more complete discussion of risk, refer to the company’s annual report and 10K filing.

Government Regulation and Health Care Reform – the government has been considering proposals to reform the U.S. health care system that may increase government involvement in health care, increase regulation of pharmacy services, result in changes to pharmacy reimbursement rates that could adversely impact earnings.

Reductions in Third-Party Reimbursement Levels - from private or government plans, for prescription drugs could reduce margins on pharmacy sales and have a significant effect on retail drugstore profits.

Constrained Geography - an inability to find suitable new store locations at acceptable prices or expiration of current leases could limit future growth.


The Numbers

Share Price ($US)   29.51 
Market Cap ($US B)   28.7 
No. Shares (M)   991 
ROE   14.0%
ROA   7.9%
P/E Ratio   14.3
Price/Sales Ratio   0.4
Price/Book Ratio   1.9
Current Ratio   1.7
Interest Coverage   39.1
Total Debt/Equity   16%

Analyst – David Scollon


Disclosure - At publication of this analysis I hold no position in this security, but may take a long position in the future. I do not take short positions in any of the stocks reviewed on this site, nor do I receive any compensation from the companies studied for publication of my opinions.


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