Walgreen’s Bottom Line Is More Than Just the Last Quarter

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Walgreen Co. (NYSE:WAG) is the nation’s second largest pharmacy chain that needs no introduction. What you may not know is that it operates 8,683 locations in all 50 states, the District of Columbia, Puerto Rico, Guam, and the U.S. Virgin Islands. The company has 8,217 drugstores nationwide, 120 more than at this time a year ago. Besides pharmacy services, Walgreens also operates worksite health and wellness centers, infusion and respiratory services facilities, specialty pharmacies, and mail service facilities.

Its Take Care Health Systems subsidiary manages more than 700 in-store convenient care clinics and worksite health and wellness centers. Walgreens’ e-commerce business includes Walgreens.com, Drugstore.com, Beauty.com, SkinStore.com and VisionDirect.com. The stock caught my eye on Tuesday, as it is down 3 percent on the back of disappointing earnings. The question is should we take advantage of the small selloff and do some buying, or should we abandon ship and take profits? To address this issue, let’s walk through the important aspects of the quarter.

The first thing you need to know is that third-quarter sales were up year over year. In fact, they increased 5.9 percent compared with the prior-year quarter to $19.4 billion. Comparable store sales were also up. They increased 2.2 percent in the third quarter, while customer traffic in comparable stores decreased 0.7 percent. Despite reduced customers, the average basket size per customer increased 2.9 percent. The Walgreens Balance Rewards loyalty program hit a new milestone, as well.

It reached 81 million active members at the end of the quarter. After sales and expenses, GAAP net earnings were $722 million, a 15.7 percent increase from $624 million in the same quarter a year ago. A big reason was the the lower tax rate rate of 31.5 percent compared with 38.7 percent last year that resulted from increased foreign income taxed at a lower rate, favorable audit settlements, certain nondeductible expenses last year, and other discrete events. Net earnings per diluted share for the quarter increased 15.4 percent to 75 cents, compared with 65 cents per diluted share in the year-ago quarter.

After accounting for some items, Walgreen’s adjusted net earnings were $883 million, an 8.7 percent increase from $812 million in the same quarter a year ago. This year’s adjusted third-quarter earnings also benefited from a lower effective income tax rate. Adjusted net earnings per diluted share for the quarter increased 7.1 percent to 91 cents, compared with 85 cents per diluted share in the year-ago quarter.

Net earnings for the first nine months of fiscal 2014 ended May 31 determined in accordance with GAAP were $2.17 billion, an increase of 21.1 percent compared with $1.79 billion in the first nine months of fiscal 2013. Net earnings per diluted share for the first nine months of fiscal 2014 increased 19.7 percent to $2.25, compared with $1.88 per diluted share in the first nine months of fiscal 2013. Adjusted net earnings for the first nine months of fiscal 2014 were $2.45 billion, an increase of 7.5 percent compared with adjusted net earnings of $2.28 billion in the first nine months of fiscal 2013.

This quarter was actually better than I thought it was when I saw that the stock had dropped 3 percent. Sales are up markedly, as were earnings. The only disappointment was a decreased customer count, but this was offset by larger average orders. Further, the acquisition of Alliance Boots is paying off handsomely. Alliance Boots contributed 15 cents per diluted share to Walgreens third quarter 2014 adjusted results.

The company estimates that the accretion from Alliance Boots in the fourth quarter of fiscal 2014 will be an adjusted 6 cents to 7 cents per diluted share. Now, this could be interpreted as meaning if this was backed out, the quarter would have been worse than it was in 2013. There is some truth to this. However, the bottom line is that the company is growing and is making more profit. So long as this path continues at its current rate, the stock is a buy. Thus, I think you can take advantage of the weakness and do some buying at the current price of $72.12.

Disclosure: Christopher F. Davis hold no position in Walgreen Co. and has no plans to initiate a position in the next 72 hours. He has a buy rating on the stock and an $80 price target.

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