analysts: matt hawk roger hong ye jiang prateek sharma 14-oct- 2010
TRANSCRIPT
Analysts:MATT HAWKROGER HONGYE JIANGPRATEEK SHARMA
14-Oct- 2010
OUTLINE
Company overviewSWOT analysisMacro economy reviewIndustry analysis/ Porter’s Five ForcesCompetitorsDCF valuationRecommendation
OUR HOLDINGS
RCMP currently owns 500 shares of WAG
WAG DETAIL
RCMP purchased WAG 1,000 shares at $25/share on Oct. 06, 1999
RCMP sold WAG 500 shares at $49.94 Realized gain: $12,470
Currently owns 500 shares trading at $34.27 (as of Oct. 17, 2010) Unrealized gain: $4,635
HISTORY
1901 Charles R Walgreens Sr. purchased Chicago Drug Store where he had worked as a pharmacist -Start of Walgreens Chain
1926 Opened 100th Store
1927 Walgreens Co. Stock went Public
1975 Sales reached $1 Billion
1984 Opened 1000th store
1994 Opened 2000th store
2005 Opened 5000th store
2009 Opened 7000th store
PRESENT
• Walgreens is a retail drugstore chain that sells prescription and non-prescription drugs, and general merchandise– As of Aug. 31, 2010, Walgreens operated 8,046 locations in all 50 states, the District
of Columbia, Puerto Rico and Guam. It employs around 238,000 people
• Sales increased 7.4 percent to a record $16.9 billion for the fourth quarter and 6.4 percent to a record $67.4 billion for the fiscal 2010
• Walgreens filled a record 778 million prescriptions in fiscal 2010 an increase of 7.5 percent. Prescription sales: 65%
RECENT EVENTS
Sept 2010 – Walgreens and Omnicare reached an agreement in which Omnicare will acquire all of the assets of Walgreens long-term care pharmacy business, and in return Walgreens will acquire all of the assets of Omnicare’s home infusion businesses
Aug 2010 – Walgreens announced an agreement with Graymark Healthcare Inc. (NASDAQ: GRMH) in which the company will acquire the assets of 18 ApothecaryRx pharmacies located in Colorado, Oklahoma, Minnesota, Missouri and Illinois
April 2010 – Walgreens acquired Duane Reade Holdings, Inc for approx $1.1bn. The transaction included all 258 Duane Reade stores in the New York City metropolitan area, as well as Duane Reade’s corporate office and two distribution centers
STOCK PERFORMANCE
MANAGEMENT
Key Executives
Mr. Gregory D. WassonPresident and CEO (Feb. 2009)
Mr. Mark A. WagnerPresident-Community Management (Sept. 2010)
Mr. Kermit R. CrawfordPresident-Pharmacy Services (Sept. 2010)
Mr. Wade D. MiquelonExecutive Vice President-Chief Financial Officer (July 2009, joined from Tyson Food in 2008)
GROWTH STRATEGY
• Three Primary Components– Leveraging the best store network in America
• Within five miles of nearly three-quarters of all Americans
– Enhancing customer Experience• Customer Centric Retailing”(CCR): feature lower shelves and about
15 percent fewer individual items, which provides a more efficient and convenient shopping experience for today’s busy consumers. (Now more than 1,800 stores)
• Beer and wine was added to more than 3,500 stores and now is available in a total of nearly 4,200 stores
– Driving cost reduction and productivity gain• Rewiring for Growth: Target for $1 billion in annual savings in fiscal
2011
SWOT ANALYSIS
Strengths Weakness
Market Leadership (approx 30% mkt share)Consolidation of market – reduced independent drug stores
Geographic Concentration - CA, FL, TX,IL, NY 40%Declining Operating Margin -5.13% in 2010 vs. 5.8% Avg. last 5 yrs
Opportunity Threat
Develop drive-thru model In-store clinics Aging Baby BoomersPatent expirations on generics in 2012/2013
From mass merchandisers ( they can afford lower margins) Mail-order businesses (offer greater convenience) Dependence on Medicare/Medicaid (reduction in rates could affect margins)
MACROECONOMIC REVIEW
Macro economy current:The tough economic conditions of 2008 and 2009 had a lasting effect on consumer behavior. Concern over high unemployment and declined consumer confidence affect customer’s spending habit. Price has become the single most important factor in making the purchase decision
Consumer confidence: Unemployment
Source:http://mjperry.blogspot.com/2010/06/consumer-confidence-highest-since-jan.html
MACROECONOMIC REVIEW
As the economy begins to strengthen in 2010 and 2011, decreasing unemployment and rising income levels should boost this industry’s pharmaceutical as well as front-end sales
Also, as more consumers gain employment, the level of insurance coverage is expected to rise, thus increasing the likelihood people will purchase pills and other medicine
Increase in health awareness among people will lead to increase in front-end sales of health related products
Increased spending by the government on Medicare/Medicaid is expected to boost sales
INDUSTRY ANALYSIS
Industry Outlook: The industry outlook is positive: Sales will maintain growth due to an aging population, longer life expectancy and healthcare reform. Revenue is forecast to grow at an average annualized rate of 3.1% to total $251.9 billion in 2015
Highly Competitive Industry M&A: The industry will slow its new store openings after decades of rapid expansion, and
consolidation will continue. Enterprise numbers will decline at an average annualized rate of 1.3% to settle at about 21,786 companies during the next five years
Price: As Mass merchants, mail-order pharmacies and PBMs (pharmacy benefit managers ) continue to pose a threat to industry sales, they place downward pressure on prices
Source:Pharmacies&Drug Stores in the US, ISBS World Industry Report 44611, July 2010
Medical reimbursement levelCertain provisions of the Deficit Reduction Act of 2005 seek to reduce federal spending by altering the Medicaid reimbursement formula for generic drugs. These changes are expected to result in reduced Medicaid reimbursement rates for prescription
Health reformExpand insurance coverage and subsequently increase pharmaceuticals’ demand as they become more affordable
The government is expected to initiate cost cutting, which could adversely affect profit margins
Source:https://materials.proxyvote.com/Approved/931422/20091116/AR_48630/HTML2/default.htm
PORTER’S FIVE FORCES
Barrier to Entry: Medium Consolidation that is creating large players with deep resources
Government and state laws and regulations
Threat of substitutes: Drugs: Low Few alternative choices, inelastic demand
General Merchandise: High Supermarkets are large threats
Bargaining power of buyers: ModerateInelastic demand but thinning profit margin
Bargaining power of suppliers: Moderate The large retailers purchase directly from several suppliers, strong relationship
Rivalry among existing competitors: HighBoth internal and external sources, including other drug store chains or independent drug stores, supermarket chains, mass merchandisers, on-line retailers and mail order pharmacies
COMPETITORS - DESCRIPTION
CVS Caremark – CVS Caremark operates in two segments – Pharmacy Services and Retail Pharmacy. The Retail Pharmacy segment sells prescription drugs, over-the-counter drugs, beauty products and cosmetics, photo finishing, seasonal merchandise, greeting cards, and convenience foods through its pharmacy retail stores and online. It operates approx. 7,000 retail stores. For the year ending 31-Dec-2009, it reported sales of $98.729B
Rite Aid Corporation – Rite Aid operates retail pharmacy stores . As of Feb 2010, it operated around 4,780 stores. It sells prescription drugs and an assortment of other merchandise. For the year ending Feb 2010, it reported a loss of $506.7M on revenues of $25.37B
COMPARATIVE RATIOS
Company WalgreensCVS
Caremark Rite Aid
Ticker WAG CVS RAD Current ROE Current ROA
Profit Margin 3.45% 3.76% -2.88% 3.1%
Asset Turnover 2.62 1.61 3.2 2.62
Equity Multiplier 1.85 1.93 - 1.79
ROE (5-yr avg.) 16.71% 11.69% -256.66% 14.53% 8.13%
Source: Capital IQ
SALES FORECAST
We have optimistic growth expectations for WAG, expecting it to rebound from the economic turmoil it faced over the past two years
($ in millions)
2010 2011 2012 2013 2014 2015 2016$67,420.0 $72,813.6 $79,148.4 $86,588.3 $92,736.1 $103,957.2 $114,352.9
6.45% 8.00% 8.70% 9.40% 7.10% 12.10% 10.00%43,823.0 47,328.8 51,446.4 57,148.3 61,205.8 68,611.7 75,472.9
% sales 65.00% 65.00% 65.00% 66.00% 66.00% 66.00% 66.00%% growth 6.45% 8.00% 8.70% 11.08% 7.10% 12.10% 10.00%
6,742.0 7,281.4 7,914.8 8,658.8 9,273.6 10,395.7 11,435.3% sales 10.00% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00%% growth 6.45% 8.00% 8.70% 9.40% 7.10% 12.10% 10.00%
16,855.0 18,203.4 19,787.1 21,647.1 23,184.0 25,989.3 28,588.2% sales 25.00% 25.00% 25.00% 25.00% 25.00% 25.00% 25.00%% growth 6.45% 8.00% 8.70% 9.40% 7.10% 12.10% 10.00%
6,997 7,561 7879 8241 8612 8956 9292New openings 564 318 362 371 344 336 325
7,561 7879 8241 8612 8956 9292 9617% organic store growth 8.06% 4.20% 4.60% 4.50% 4.00% 3.75% 3.50%% Same store sales 1.98% 3.60% 4.50% 5.00% 5.20% 5.50% 5.60%
Stores, ending
FORECASTEDFY Ending 8/31Sales Forcasted From Stores% Sales Growth
Prescription Sales
Non-prescription Sales
General Merchandise
Stores, beginning
GROWTH DRIVERS
"Our use of cash has been, and will continue to be, guided by a capital policy that commits us to maintaining a strong balance sheet and financial flexibility; reinvesting in core strategies and related strategic activities; and returning surplus cash to shareholders in the form of dividends and share repurchases,“
- Greg Wasson
GROWTH DRIVERS (Cont.)
1. Strong balance sheet and financial flexibilitya) Allows WAG to return income to shareholders in the
form of dividends and stock repurchases
2. Slow store growth to free up capital and focus on WAG’s core business
3. 2009 Repurchase Program4. “2008 Rewiring for Growth” Program
a) Enhance the customer experience (CCR)b) Extend their presence in pharmacy, health and wellness
servicesc) Cost reduction and productivity gain
5. Reduce on-hand inventorya) Eliminate 3,500 products
Source:http://news.walgreens.com/article_display.cfm?article_id=5260
RESULTS
Sustain long-term revenue growthIncrease margins through cost reduction
(“Rewiring for Growth”) 2010 - $600 million cost reduction 2011 - $1000 million cost reduction ($400 million net gains)
Double digit EPS growth30-35% return to shareholders
Low leverage allows WAG to compensate equity holders
Source:http://news.walgreens.com/article_display.cfm?article_id=5260
ROE
2010 2011 2012 2013 2014 2015 2016Tax Burden 61.99% 63.47% 63.47% 63.47% 63.47% 63.47% 63.47%Interest Burden 97.54% 96.81% 97.55% 97.53% 97.69% 98.06% 98.36%Profit Margin 5.13% 4.97% 5.96% 6.51% 6.50% 6.90% 7.42%Asset Turnover 256.59% 260.51% 258.25% 256.77% 252.00% 256.00% 254.41%Leverage Ratio 182.47% 173.20% 172.50% 171.00% 170.00% 169.50% 168.50%ROE 14.52% 13.79% 16.43% 17.70% 17.27% 18.64% 19.86%
FORECASTED
DEBT SCHEDULE(WITHOUT OPERATING LEASES)
($ in millions) Book Interest Debt / Estimated MaturityValue Rate Yield LTM EBITDA Interest Date
Cash $2,087.0Secured DebtRevolving Credit Facility 0.0 L + .525% 0.0 Nov-11 Unsecured Debt4.875% Senior Notes 1,294.0 4.88% 63.1 Aug-135.250% Senior Notes 995.0 5.25% 52.2 Jan-19Variable Loans 57.0 NA NA
Total Debt $2,346.0 .6x $115.3
Preferred Stock 0.0Shareholders' Equity 34,008.3Total Capitalization $36,354.3Debt/ Capitalization 6.45% 2009 EBITDA 4,222.0
Capital Expenditures 1,927.0Cash 2,087.0Revolver Availability 1,200.0 2009 EBITDA / Interest Expense 36.6xTotal Liquidity $3,287.0 (2009 EBITDA - Cap Ex) / Interest Expense 19.9x
CAPITALIZATION SUMMARY
2009 CREDIT STATISTICS
DEBT SCHEDULE(WITH OPERATING LEASES)
Although WAG doesn’t have much long-term debt, its operating leases make it a muchmore highly levered company
($ in millions) Book Interest Debt / Estimated MaturityValue Rate Yield LTM EBITDA Interest Date
Cash $2,087.0Secured DebtRevolving Credit Facility 0.0 L + .525% 0.0 Nov-11 Unsecured Debt4.875% Senior Notes 1,294.0 4.88% 63.1 Aug-135.250% Senior Notes 995.0 5.25% 52.2 Jan-19Variable Loans 57.0 NA NA
Operating Leases 19,869.8 2,024.0 NA
Total Debt $22,215.8 5.3x $2,139.3
Preferred Stock 0.0Shareholders' Equity 34,008.3Total Capitalization $56,224.1Debt/ Capitalization 39.51% 2009 EBITDA 4,222.0
Capital Expenditures 1,927.0Cash 2,087.0Revolver Availability 1,200.0 2009 EBITDA / Interest Expense 2.xTotal Liquidity $3,287.0 (2009 EBITDA - Cap Ex) / Interest Expense 1.1x
2009 CREDIT STATISTICS
CAPITALIZATION SUMMARY
WACC – W/ OPERATING LEASES
Risk Free Rate (Rf)
2.46%
Beta 0.82
Market Risk Premium
6.00%
Cost of Equity (CAPM)
7.38%
Cost of Debt 5.25%
Tax Rate 36.53%
Cost of Debt (After-tax)
3.33%
Weight of Equity 0.605
Wight of debt 0.395
WACC 8.63%
CAPM COMBINED ROE
7.38% 12.09% 16.79%
COST OF EQUITY
Cost of Debt WACC Cost of Equity
3.33% 8.63% 12.09%
Weight: 39.50%
Weight: 60.50%
DCF – W/ OPERATING LEASES
($ in millions) 1 2 3 4 5 6Forecasted FCF's: 2,144.6 1,427.0 1,613.7 1,828.0 2,052.1 2,326.7Terminal Value 52,296.9Discount Factor: 0.921 0.847 0.780 0.718 0.661 0.609
Discount FCF's $1,974.2 $1,209.3 $1,258.9 $1,312.8 $1,356.8 $33,247.0
Discount Rate 8.63%Terminal Growth Rate 4%Enterprise Value $40,359.1Net Debt 22,215.8Equity Value 18,143.3
Shares Outstanding 977.25
Share Price $18.57
DCF ANALYSIS (WITH OPERATING LEASES)
$18.57 7.5% 8.0% 8.5% 8.63% 9.0% 9.5% 10.0%2.5% 17.93 14.13 10.96 10.24 8.28 5.99 4.003.0% 21.62 17.07 13.36 12.52 10.26 7.65 5.413.5% 26.23 20.67 16.24 15.25 12.61 9.59 7.034.0% 32.15 25.18 19.76 18.57 15.42 11.88 8.934.5% 40.05 30.96 24.15 22.69 18.86 14.63 11.175.0% 51.10 38.68 29.81 27.95 23.16 17.99 13.865.5% 67.69 49.48 37.35 34.88 28.69 22.19 17.14
TE
RM
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GR
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RATE
WACC
SENSITIVITY ANALYSIS (WITH OPERATING LEASES)
RELATIVE VALUATION
Parameter Ratio Value
P/E(ttm): 16.22 $34.41
Forward P/E 13.50 $28.89
P/S(ttm) 0.49 $32.36
P/B 2.31 $32.40
Price Range: $28-34
PERFORMANCE OVER TIME
RECOMMENDATION
Hold 500 shares at current priceAny merger or acquisition in the industry
could provide stimulus to stock priceRegular dividend paying stockConsistently outperformed both S&P 500 and
DJIA