Time to Invest in America's Largest Pharmacy?

Walgreen Co. , the largest owner and operator of pharmacies in the United States, announced its third-quarter earnings results on June 24 and its stock reacted by making a move to the downside. It's not often that we see a pullback in this American titan, so let's take a look at the results and other key financials and then compare it to its largest competitor, CVS Caremark , to determine if this decline is our opportunity to buy or if there is an underlying issue that is warning us to stay away.

Source: Walgreen Co.

Walgreen mixes it up in the third quarter
Walgreen released its third-quarter report before the market opened on June 24 and the results were mixed compared to the consensus analyst estimates; here's an overview:

Earnings Per Share$0.91$0.94
Revenue$19.4 billion$19.3 billion

Source: Benzinga

Walgreen's earnings per share increased 7.1% and revenue increased 5.9% year-over-year, driven by an impressive 4.8% comparable-store sales rise; this strong growth in comparable-store sales was helped by an 8.4% increase in prescription sales, which accounted for 64.4% of total sales during the quarter. Walgreen also noted that it now owns an incredible 19% share of the retail prescription market, up 20 basis points from the year-ago quarter.  

Source: Walgreen Co.

Gross profit increased 4.2% to $5.44 billion and operating profit increased 3.5% to $1.03 billion, but the gross margin contracted 40 basis points to 28.1% and the operating margin contracted 10 basis points to 5.3%; these contractions resulted from cost of sales increasing 6.6% and selling, general, and administrative expenses increasing 4.3%. 

For the quarter, Walgreen had roughly $1 billion of free cash flow; the company used this free cash and the $2.11 billion in cash and cash equivalents it had at the beginning of the quarter to retire $742 million in long-term debt, pay $301 million in dividends, and open two new stores; as of the conclusion of the third quarter, the company had $3.75 billion in long-term debt, $2.13 billion in cash and cash equivalents, and 8,683 stores in all 50 of the United States, the District of Columbia, Puerto Rico, Guam, and the U.S. Virgin Islands. 

Source: Walgreen Co.

So were these results good, bad, or so-so?
With all of the results in hand, I think it was a great quarter for Walgreen, regardless of whether or not it met the expectations of analysts, but the stock reacted by falling 1.7% on the day of the release; in the trading days since, the stock has traded erratically, but I believe it represents a great long-term opportunity at current levels. Here are my three top reasons why Walgreen's belongs in your portfolio today:

  1. Prescriptions: Sales of prescriptions have shown consistent growth over the last decade and I believe this trend is here to stay; with a now 19% share of this market, Walgreen's is by far the best way to play it.
  2. Expansion: Walgreen's currently has more than 8,600 stores, but there are still plenty of untapped markets for it to expand to. I believe the company could easily grow its store count to 10,000 over the long-term.
  3. Joint Venture with Alliance Boots: Walgreen's and Alliance Boots entered into a joint venture to form the world's first "pharmacy-led, healthy and wellbeing enterprise" in August of 2013 and it has already positively affected the financials of both companies. The two companies will continue to build on this relationship and I believe it could be one of the main drivers of Walgreen's growth going forward.
With all of this being said, I must reiterate that I believe Walgreen's represents a great long-term opportunity.

A record quarter for the competition
CVS Caremark, the second-largest owner and operator of pharmacies in the United States, released earnings of its own back on May 2 and it too reported mixed results; here's a summary of its first quarter:

Earnings Per Share$1.02$1.04
Revenue$32.69 billion$32.31 billion

Source: Benzinga

Earnings per share increased 22.5% and revenue increased 6.3% compared to the same period a year ago, as comparable-store sales grew 1.4%; these results were driven by a 10.3% increase in revenue from its pharmacy services segment and a 2.7% increase in its retail pharmacy segment. 

Source: Wikimedia Commons

CVS' gross profit increased 6.5% to $5.94 billion and operating profit increased 19.5% to $2.02 billion, as its gross margin expanded 10 basis points to 18.2% and operating margin expanded 70 basis points to 6.2%; cost of sales and operating expenses increased just 6.2% and 0.9%, respectively, which enabled the margin increases. 

Lastly, CVS generated $1.8 billion in free cash flow during the quarter which allowed it to repurchase $801 million worth of its common stock, pay $325 million in dividends, open 15 net new retail drugstores, and reaffirm its full-year outlook, among other things. The company now operates 7,829 locations in 47 states, the District of Columbia, Puerto Rico, and Brazil.

All in all, it was a healthy quarter for the No. 2 company in the industry. I believe CVS could provide substantial returns over the next several years, so investors who are not sold on Walgreen's potential should take a deeper look at it.

The Foolish bottom line
Walgreen Co. is one of the most powerful brands in the United States and its now 19% share of the retail prescription market proves that it is a growing force to be reckoned with. The company's stock took a slight hit after mixed third-quarter earnings, but I believe the long-term potential of Walgreen far outweighs any short-term negativity so Foolish investors should give it a second look.

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The article Time to Invest in America's Largest Pharmacy? originally appeared on Fool.com.

Joseph Solitro has no position in any stocks mentioned. The Motley Fool recommends CVS Caremark. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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