No Need to Panic, Walgreen Investors: Here's Why
Walgreen (NYS: WAG) fans have seen the headlines: "Walgreen Profit Slides 55%." Well, that can't be good, can it? Actually, once you make it past the catchy title and break down Walgreen's actual fiscal fourth-quarter results, turns out the sky isn't falling after all.
It was a busy year for Walgreen CEO Greg Wasson and team, and its various moves -- a key acquisition and the love/hate relationship with Express Scripts (NAS: ESRX) , to name a couple -- had as much to do with fourth-quarter financial results as anything else.
By the numbers
Those eye-popping headlines screaming "55% drop in profit?" They aren't lying. Walgreen reported GAAP net earnings of a mere $0.39 a share on Sept. 28, down from Q4 2011's $0.87. Now GAAP reporting requirements are a good thing; they make it easier for investors to compare apples to apples, usually.
Unfortunately, when you have an activity-filled quarter, and year, like Walgreen did, a review of non-GAAP results is warranted. All the one-time items, gains and losses, need to be accounted for to get an accurate picture of operating results. Of course with Walgreen, there's the infamous Express Scripts affiliation to throw into the mix as well.
Speaking of operating results, Walgreen absolutely killed fiscal-year operating and free cash flow numbers, setting company records in both areas. The $4.4 billion in operating cash flow, along with $2.88 billion generated in free cash flow, are stellar, continuing Walgreen's top-of-the-charts dividend yield.
When you consider that Walgreen spent large parts of fiscal 2012 without the benefit of the Express Scripts partnership, annual revenues weren't nearly as bad as the headlines would have you believe. In 2011, Walgreen had net sales of $72.1 billion. It ended 2012 with $71.6 billion in revenue, all of a 0.08% decline.
The envelope, please
There are two significant things that affected Walgreen GAAP results. No. 1, the $6.7 billion purchase of a 45% stake in European pharmacy leader Alliance Boots in June of this year shaved approximately $0.09 a share off GAAP earnings, plus an additional $0.05 for "acquisition-related costs." The hit on Walgreen financials today could pay huge dividends going forward. The combination of Walgreen and Alliance immediately creates one of the largest retail pharmacies in the world.
The timing of the Alliance Boots deal was a bit tricky as it relates to Walgreen's announcement of fiscal fourth-quarter results. Earnings took a hit because of expenses associated with the transaction, but it was too late for Walgreen to include Alliance's operating results. We'll get a clearer picture of what Alliance adds to the Walgreen bottom line in Q1 2013.
Then there's Express Scripts. The on-again, off-again partnership with the pharmacy network provider hit Walgreen hard in the fiscal fourth quarter. Walgreen estimates the loss of Express Script revenues in Q4 cost it to the tune of $0.06 share in earnings, $0.21 a share for the fiscal year. Now that the two are back in each other's good graces, Walgreen can move onward and upward.
This is getting good
As we discussed in an article early last month, CVS Caremark (NYS: CVS) was all the rage after the Walgreen/Express Scripts fiasco. Caremark CEO Larry Merlo, after posting record earnings, wasn't shy in sharing his excitement. Menlo didn't hold back on how CVS was able to post those results, either: aggressively marketing to "former" Walgreen customers after it parted ways with Express Scripts.
But here's the thing: Even as CVS was announcing great results, Walgreen was still the better investment opportunity. Why? Because the Express Scripts situation was going to be resolved, Walgreen's Wasson really didn't have any choice. Also, from a fundamental perspective, Walgreen was an outstanding value in comparison to CVS. The beauty of it is, Walgreen is an even better investment option today.
At 12.42 times earnings, Walgreen is trading at a steep discount to CVS' nearly 17 P/E. ROA, ROE, and profit margins are all in favor of Walgreen. And at 3%, Walgreen's dividend yield is more than twice that of CVS.
The "55% Drop in Profit" headlines are just that, headlines. Once the initial panic ebbs, Walgreen will still be the best value in the industry.
If you believe in the slow but steady return of the global economy, retail offers solid, long-term investment opportunities. Ah, but which retailer to choose? Take a look at our special free report for the details on a retail giant you may not have heard of. Click here to get your copy today.
The article No Need to Panic, Walgreen Investors: Here's Why originally appeared on Fool.com.Fool contributor Tim Brugger currently holds no securities positions mentioned in this article. The Motley Fool owns shares of Express Scripts Holding. Motley Fool newsletter services have recommended buying shares of Express Scripts Holding. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.