This Drug Store’s Rally Is Far from Over

Walgreens Pharmacy

(Photo credit: davidyuweb)

Drug retailers may not score as big as the manufacturer when a certain drug passes the test. On the other hand, they carry little risk once the drug is released. This offers an alternative for risk-averse investors who seek to invest in the Pharma related industries. Walgreen (NYSE: WAG), which is one of the world’s largest drug stores, is down more than 13% from its 52-week high of $51.25 reached on May 28.

Much of this decline came in the last two weeks, with the company’s recent miss on earnings estimates worsening the situation. Some investors have already panicked as the company moved more than 10 million shares on a daily basis over the last week. The question is, should you be offloading Walgreen? Well, probably not.

Recent decline and inked deals mean buy now

Before Walgreen’s recent plunge, the company was trading just under the nose of its 52-week high. Many would have hoped for it to continue rallying, but unfortunately that did not turn out to be the case.

For those who were seeking for a perfect opportunity to invest in this drug store, now is the time. With the company trading at 13% below its 52-week high, there is not a better opportunity to get yourself in the act. Walgreen’s fundamentals are up there among the industry’s best, and its outlook is extremely promising.

Walgreen collaborated with Alliance Boots in tying up a deal with AmerisourceBergen,expected to take effect beginning Sept. 1, 2013. The strategic partnership with Alliance Boots ensured that no major legal hurdles would come to play in the deal. This enabled Walgreen to execute the 10-year deal cost-effectively.

AmerisourceBergen is a pharmaceutical services company involved in the distribution of drugs and related healthcare services. This is expected to give Walgreen a wider market reach as it seeks to counter competition from industry rivals such as CVS Caremark (NYSE: CVS) andRite Aid (NYSE: RAD).

Walgreen and Alliance Boots could end up owning as much as 25% stake in AmerisourceBergen by 2017, while buying 7% of that publicly from the market any time after September 1. AmerisourceBergen will benefit from its access to generic drugs and related pharmaceutical products through the Walgreen Boots Alliance Development joint venture.

This will give the Chesterbrook, PA-based drug merchant the opportunity to fast-track efforts in growing its specialty and manufacturer services businesses domestically and internationally. The decade-long deal also gives Walgreen the opportunity to capitalize on its wider market reach and, in terms of return on investment, the success of AmerisourceBergen.

There were plenty of positives in Walgreen’s most recent quarter results

Walgreen missed analyst estimates on profit, thereby making headlines for all of the wrong reasons. There was many good takes from the company’s most recent quarterly earnings report, however. The fact that earnings grew by 16% year-over-year while sales increased by 3.2% is worth noting.

The 3.2% growth in revenues may seem too small, but it was better than Walgreen’s rivals. Rite Aid’s revenue fell by 2.7% year-over-year, while CVS Caremark’s was down 0.1%. Comparable-store prescription sales were up 2%, while overall prescriptions increased by 8.7% from the same quarter last year. Prescriptions accounted for 63.1% of Walgreen’s revenues. The company’s gross profit was up 4.1% from last year, while cash increased by 50.1%, to nearly $3 billion.

Walgreen’s comparable store sales increase of 2% compares to Rite Aid’s decline of 1.5% in May. Likewise, CVS Caremark’s same-store pharmacy sales fell by 2.3% in the most recent quarter. CVS’s most recent quarterly earnings rose 23% to $956 million, compared to last year’s $776 million.

On the other hand, Rite Aid’s earnings per share grew by 400% from last year when the company reported a loss of $0.03 to $0.09. The company’s earnings were in line with expectations, while revenues beat analyst estimates marginally by about 20 million. Rite Aid reported $6.29 billion worth of revenues in the most recent quarter.

Valuation

At $44.46 per share, Walgreen currently trades 19.45 times in price to earnings ratio (P/E). This is slightly above CVS Caremark’s 18.22 and Rite Aid’s 11.28. When we factor in the projected earnings growth rates for the next five years, however, Walgreen is not as expensive as it seems.

The company trades at 1.08 times its price to earnings growth

ratio (PEG), compared to Rite Aid’s 2.24. CVS Caremark seems to be a little cheaper, trading at 1.05 times PEG. This indicates that the company’s recent plunge has resulted into significant underpricing while its outlook remains promising.

The bottom line

It is a common behavior that when a company misses analyst estimates on earnings, the company’s stock suffers. It is also common that in most cases the fall is temporary, especially for a company with a bright outlook. Walgreen is certainly a company with a price that is suffering just because of missing analysts’ estimates on profits.

The company is up 16% year-to-date, and more than 50% from twelve months ago. Has this rally ended following the recent decline? I do not think so, especially given the company’s huge market share and recent partnerships.

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