Walgreens (NYSE: WAG)Why I Like It:1. Durable, stable business that is resistant to recessionary pressures. Walgreens has been in existence for almost 110 years and has raised its dividend for the 32nd consecutive year.2. Walgreens is the number 2 drugstore chain in the industry. In terms of store count, it is one of the fastest growing retailers in the United States. 3. Very soon, there will be a bunch of blockbuster drugs coming off patents. Walgreens enjoys better gross margins off of generics. Further, Baby Boomers are reaching the age where they will need to take more drugs. Both of these trends bode well for the industry and large players such as Walgreens4. In 07, it owned 16.7% of the prescription market, totaling 583M prescriptions.5. Its drugstores average $8.9M in annual sales which works out to be an impressive $797 dollars per square foot. For perspective, Walgreens serves over 5M customers daily.6. Walgreen focuses on acquiring the best real estate and building stand alone locations. Free standing stores are estimated to generate 30% more in volume than those in a strip format. 7. It compares favorably to its primary competitor - CVS. WAG has better real estate, better margins, and better returns on equity and assets. Business:Walgreens is a retail drug store chain that sells prescription and non prescription drugs and general merchandise. It operates 7000 stores and expects to saturate the United States market when it hits 13000. Key metrics for this business are dollars per square foot, gross margins (currently 28.2% the highest it’s been since 94), SSS, prescription penetration, and total prescriptions filled. Its competition is primarily CVS, but also any local drugstore, grocery store, big box retailer, and online pharmacies. Competitive advantages include convenience, scale, its commitment to stand alone locations (real estate), and brand. Prescriptions currently represent 65.5% of total sales, the rest comes from what they call the front end of which HABA, GM, candy etc is included.Risks:1. Reliance on prescription drugs makes it very susceptible to government regulation. For example, Medicare makes compounds the same price no matter where you shop. Also, the government has been known to regulate fees paid to drugstores by manufacturers during the generic introductory period. This squeezes margins. The bright side? These rules apply to everyone and favor the best operators. 2. It’s not a low price operator. Walgreens is not willing to sacrifice margin to match Wal-Mart/Target. It realizes that price is not an effective advantage. I think that is more of a positive than a negative.3. I’ve noticed that stores are becoming increasingly focused on impulse buys. It’s packing its front end with more Sku’s than it has in the past. This is causing a law of diminishing returns as it is getting away from its core strength; Walgreens is best known for being a convenient stand alone drug store. The CEO has admitted that stores are getting full and he is committed to cutting out some of the product mix. This strategy makes sense as a recent study has shown that only 30% of drugstore shoppers make impulse purchases.Management:Based on MDP principles I grade out Walgreens management at an A-Ownership – Currently insiders own less than 1% of the company. I would like to see management have more financial ties to the Walgreen’s performance.Allocation – I think this is a definite strength. For perspective CVS Roe stands at 9.5% with WAG being 8.5 points better at 18%. Despite recent events, the company generally prefers to focus on generic growth (rather than through acquisition), which helps with continuity among other things. It uses cash generated from operations to fund all of its growth. Tenure – I think that current Ceo Jeffrey Rein is the right man for the job. He has worked his way through the company starting as an Assistant Mgr in 1982. His tenure spans more than 25 years. Stewardship – I believe the company to be fully aligned with shareholders. Mr Rein’s salary was 3.09M in 07, which represented less than 1% of net income. Not surprisingly, stock based compensation was only $68M or 3.2% of earnings. Aside from internally funding growth, Mgmt returns the companies annual $2B+ free cash hoard to shareholders through buybacks ($1B) and dividends ($300M in 07).Valuation:Trading at 2.5 times book and well below its 10 yr P/E and P/S averages, the stock is currently attractively priced. Assuming an 11% short term growth rate, I value WAG at around $42 per share. If I’m close that would yield a 20%+ safety net. I consider today’s price to be solid considering Walgreens is such an effective operator.
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