EUR 850.00 For Business Accounts Only

Morningstar | Maintaining Our Walgreens FVE After Fiscal 1Q; Fighting Headwinds With Collaborations and Cost Cuts

Walgreens Boots Alliance reported results for its first quarter of fiscal 2019 (through November 2018) that are consistent with our expectations, and we don't expect any significant changes to our valuation. Overall, the firm's top line increased 9.9%, heavily driven by the Rite-Aid store acquisition in March 2018 (growth excluding Rite-Aid was closer to 3%, or 4.3% at constant currencies). On the bottom line, gross margin pressure was countered by a strong benefit from U.S. tax reform (adjusted tax rate fell from 25% to 16%), which allowed for 7% adjusted net earnings growth, and share repurchases drove adjusted EPS growth even higher to 14%. Given the tailwinds from tax reform this quarter (annualizing at the start of calendar 2019) and the continuing tailwind from $3 billion in expected share repurchases this fiscal year, we think the 7%-12% adjusted EPS growth guidance (at constant currency) for the full fiscal year is reasonable. A new cost-cutting program, with savings of more than $1 billion annually expected in three years, should also help counter the persistent headwinds the firm faces. We see shares as fairly valued, and we continue to see the competitive landscape in the pharmacy business (consolidation at competitors and drug pricing weakness) and uncertainty surrounding retail growth contributing to its lack of an economic moat.

On Dec. 19, Walgreens also announced a new collaboration with Verily, the healthcare subsidiary of Alphabet, that is focused on using technology to reduce costs and improve care for patients with chronic conditions. Walgreens is starting with a small pilot project to improve medication adherence and a partnership with Sanofi on diabetes management for Walgreens employees, so the potential benefits to Walgreens' bottom line are not likely to be apparent in the near term. This builds on Walgreens' prior collaborations with firms including Kroger, FedEx, and Humana, which are aimed at increasing convenience for customers.

Diving into the quarter's results, top-line strength in the U.S. pharmacy business countered continued weakness in U.S. retail and international pharmacy, and U.S. pharmacy gross margins continue to see reimbursement and contract pressure. In the U.S. pharmacy business, sales growth of 14.4% translated to 4.6% organic growth, excluding the Rite-Aid acquisition. Gross margins in this division were down 180 basis points, due to a specialty shift (dilutive contract comps get better in January 2019) and reimbursement pressure. U.S. pharmacy sales saw 2.8% comparable pharmacy growth as the firm gained prescription share, but U.S. retail sales were down 3.2% on a comparable basis because of de-emphasis of tobacco and a very strong first quarter of fiscal 2018 (attributed to hurricanes and a strong cold/flu season). Even after adjusting for currency headwinds, an accounting change, and a divestiture, sales at Walgreens international pharmacy segment declined organically by 2.3%; in the U.K., Walgreens cited strong relative performance in an overall, weakening retail pharmacy market, and we don't expect these trends to reverse in the near term.

Walgreens saw a 70-basis-point hit to adjusted operating margin in the quarter (adjusted operating income down 4%), with pressure in its largest U.S. retail pharmacy segment (down 70 basis points) but also in both international retail pharmacy (down 200 basis points) and distribution (down 20 basis points, which was largely due to currency impacts, as emerging market growth remains strong). This is despite continued cost-cutting and improvement in SG&A as a percentage of sales in the existing U.S. retail pharmacy segment, as SG&A pressure in U.S. retail pharmacy was largely due to Rite-Aid.