Walgreens Beats Q1 Earnings, Alliance Boots Deal Bears Fruit

Walgreen Co. (WAG - Analyst Report) reported adjusted net earnings of 81 cents per share in the first quarter of fiscal 2015, up 12.5% from the year-ago adjusted number. The adjusted figure also beat the Zacks Consensus Estimate of 74 cents by 9.5%.

A year-over-year high-single-digit increase in the revenues primarily resulted in this bottom-line improvement.

Walgreen Co - Earnings Surprise | FindTheBest

In Aug 2012, Walgreens had entered into a strategic partnership with a global international pharmacy-led health and beauty group Alliance Boots GmbH, in which it acquired a 45% stake for $6.7 billion. This alliance fits Walgreens' strategy to advance community pharmacy and bring additional specialty pharmacy products and services closer to patients.

So far, Walgreens' partnership with Alliance Boots has been yielding positive results, with combined synergies reaching $140 million in the reported quarter. Moreover, Alliance Boots contributed 11 cents per share to Walgreens' first-quarter fiscal 2015 adjusted net earnings.

The company expects this joint synergy program to deliver approximately $650 million in fiscal 2015.

On a reported basis (including certain one-time items), net earnings came in at $809 million or 85 cents per share, an improvement of 16.4% or 18.1% respectively from the year-ago net earnings of $695 million or 72 cents per share.

Quarter in Detail

During the reported quarter, Walgreens' total sales reached $19.6 billion in the first quarter, registering sales growth of 6.7% year over year and a comfortable beat over the Zacks Consensus Estimate of $19.4 billion. This sales result came in line with the preliminary November sales figures posted by Walgreens in the first week of December.

In the reported quarter, Walgreens delivered solid performance across both its pharmacy and retail products businesses, which resulted in the top-line improvement.

Front-end comparable store (those open for at least a year) sales and basket size grew 1.5% and 4.2%, respectively, in the quarter. Overall, comparable store sales improved 5.7%. On the other hand, customer traffic in comparable stores was down 2.7%.

Pharmacy sales (accounting for 66.8% of total sales in the quarter) climbed 9% over the prior-year quarter, while pharmacy sales in comparable stores increased 8.1%. Moreover, Walgreens filled a record 222 million prescriptions (up 4.3% year over year) during the reported quarter.

Prescriptions filled at comparable stores rose 4.1%. As of Nov 30, Walgreens retail prescription market share on a 30-day adjusted basis reached 19%, as reported by IMS Health.

Notably, Walgreens has completed its financing to seal the Alliance Boots transaction. The company expects to close the second step of the transaction on Dec 31, 2014, following the special meeting of shareholders to be held on Dec 29 in New York City.

Margins

Adjusted gross profit increased 2.6% year over year to $5.35 billion. However, as expected, adjusted gross margin contracted 100 basis points (bps) to 27.3% as pharmacy gross profit was negatively impacted by lower third-party reimbursement and generic drug price inflation, partially offset by an increase in the brand-to-generic drug conversions.

However, as expected, both pharmacy and front-end margins gained from purchasing synergies from the company's joint venture with Alliance Boots.

Adjusted selling, general and administrative (SG&A) expenses scaled up 1.7% to $4.3 billion. Adjusted operating margin remained flat at 5.2%.

Our Take

Walgreens reported an impressive first quarter fiscal 2015 with both the top and bottom line comfortably beating the Zacks Consensus Estimate. Management is encouraged by the fact that its 8,200-plus stores have successfully exceeded the overall retail market in year-over-year sales growth heading into the holiday season. Also, Walgreens has observed faster growth in its gross profit than its costs during the quarter.

There is no doubt that the generic wave in the pharmaceutical industry has been adversely affecting Walgreens' store pharmacy sales and posing a threat to the company's profitability for quite some time. This is evident from the 100 bps-contraction observed in the company's gross margin in the first quarter of fiscal 2015.

Nonetheless, Walgreens is poised to generate higher profits from escalating sales of higher-margin generic drugs. The company is also positioned on a healthy dividend growth track.

We currently look forward to synergies from the Alliance Boots deal expected in fiscal 2015. The deal with AmerisourceBergen Corporation (ABC - Analyst Report), likely to create a leader in the generic and branded drug purchasing space, is another major upside.

Walgreens currently has a Zacks Rank #3 (Hold). Some better-ranked companies worth reckoning in the medical sector are Affymetrix Inc. (AFFX -Analyst Report) and Cytokinetics, Inc. (CYTK - Snapshot Report). All three stocks sport a Zacks Rank #1 (Strong Buy).