EUR 850.00 For Business Accounts Only

Morningstar | Walgreens Reports a Mixed 4Q as Headwinds Continue to Pressure Its Operations

Walgreens reported a mixed fourth quarter as it integrates the Rite Aid acquisition and formulates a new strategy that will have to incorporate several moving parts. Even with the tumultuous operating environment, the firm’s results fall in line with our analysis, and we are reiterating or no-moat rating and $73 fair value estimate. The firm has struggled to cope with a rapidly changing pharmaceutical market with pressured reimbursement, massive consolidation, and increasing competition for prescription volume. The firm has basically sought a two-prong strategy of building scale by acquiring Rite Aid and partnering with other drug supply chain players while also trying to drive nonpharma sales, particularly cosmetics. We are largely positive regarding the firm’s efforts to build scale through its acquisition and many partnerships. The WBAD generic sourcing consortium is an example as this joint venture has helped the firm obtain lower generic pricing and preserve at least a material portion of its gross profitability. We also believe the firm’s partnership with a mass retailers/supermarkets and the acquisition of Rite Aid will help scale its operations.

However, we are not as positive about Walgreens’ nonpharma sales strategy. To backfill the lower level of pharmaceutical profit, management has tried to increase sales of front-of-the-store (nonpharma) products. However, front-store sales have continued to drag, with same-store sales for this category falling 2%. Management did mention it is rationalizing its promotional strategy and has started to “de-emphasize” cigarette sales, which weighed on it results. Nevertheless, same-store front-end product sales have been negative in 10 of the last 11 quarters. This trend is concerning but falls in line with our outlook for these products, in particular cosmetics. We believe management would be better served investing in creating a more healthcare-centric operating model.

In the pharmaceutical industry, no entities are better known to U.S. residents than retail pharmacies. Combined with prime retail locations, stringent legal requirements, specialized personnel needs, and an essential core product, one might think these firms are positioned to consistently produce economic profits. However, we believe Walgreens faces steep long-term headwinds, as it is struggling with margin compression. The firm has had to discount its drug inventory in order to drive store traffic and has had to try and drive front-store sales to offset profit pressure. As results from the last several quarters have indicated, this strategy has yet to show it can indeed preserve and grow profitability for Walgreens. From our perspective, the firm’s long-term profit outlook remains uncertain, and we see long-term challenges ahead for the retail pharmacy. Significant consolidation among the major pharmacies and the various shifts in strategy away from core pharmaceutical sales for the major retail chains underscore the tightening operating environment.