14-Oct- 2010
Analysts:
MATT HAWK
ROGER HONG
YE JIANG
PRATEEK SHARMA
OUTLINE
 Company overview
 SWOT analysis
 Macro economy review
 Industry analysis/ Porter’s Five Forces
 Competitors
 DCF valuation
 Recommendation
OUR HOLDINGS
 RCMP currently owns 500 shares of WAG
Market Value (As of 13-Oct)
WFR
7%
WAG
15%
AEO
37%
Cost Basis
AEO
20%
WFR
25%
BGC
7%
MOS
12%
DO
4%
WAG
15%
MCD
13%
JKHY
9%
DO
3%
BGC
4%
MOS
13%
MCD
12%
JKHY
4%
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
1927
1975
Opened 100th Store
Walgreens Co. Stock went Public
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 nonprescription 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. Wasson
President and CEO (Feb. 2009)
Mr. Mark A. Wagner
President-Community Management (Sept. 2010)
Mr. Kermit R. Crawford
President-Pharmacy Services (Sept. 2010)
Mr. Wade D. Miquelon
Executive 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
•
–
Enhancing customer Experience
•
•
–
Within five miles of nearly three-quarters of all Americans
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 Boomers
Patent 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 level
Certain 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 reform
Expand 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
General Merchandise: High
Few alternative choices, inelastic demand
Supermarkets are large threats
 Bargaining power of buyers: Moderate
Inelastic demand but thinning profit margin
 Bargaining power of suppliers: Moderate
The large retailers purchase directly from several suppliers, strong relationship
 Rivalry among existing competitors: High
Both 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 $25.37B
COMPARATIVE RATIOS
CVS
Caremark
Company
Walgreens
Ticker
WAG
CVS
RAD
Current ROE
Profit Margin
3.45%
3.76%
-2.88%
3.1%
Asset Turnover
2.62
1.61
3.2
2.62
Equity Multiplier
1.85
1.93
-
1.79
ROE (5-yr avg.)
16.71%
11.69%
-256.66%
14.53%
Source: Capital IQ
Rite Aid
Current ROA
8.13%
SALES FORECAST

We have optimistic growth expectations for WAG, expecting it to rebound from the economic
turmoil it faced over the past two years
($ in millions)
FY Ending 8/31
Sales Forcasted From Stores
% Sales Growth
Prescription Sales
% sales
% growth
Non-prescription Sales
% sales
% growth
General Merchandise
% sales
% growth
Stores, beginning
New openings
Stores, ending
% organic store growth
% Same store sales
2010
2011
$67,420.0 $72,813.6
6.45%
8.00%
43,823.0
47,328.8
65.00%
65.00%
6.45%
8.00%
6,742.0
7,281.4
10.00%
10.00%
6.45%
8.00%
16,855.0
18,203.4
25.00%
25.00%
6.45%
8.00%
6,997
564
7,561
8.06%
1.98%
7,561
318
7879
4.20%
3.60%
2012
$79,148.4
8.70%
51,446.4
65.00%
8.70%
7,914.8
10.00%
8.70%
19,787.1
25.00%
8.70%
7879
362
8241
4.60%
4.50%
FORECASTED
2013
$86,588.3
9.40%
57,148.3
66.00%
11.08%
8,658.8
10.00%
9.40%
21,647.1
25.00%
9.40%
8241
371
8612
4.50%
5.00%
2014
$92,736.1
7.10%
61,205.8
66.00%
7.10%
9,273.6
10.00%
7.10%
23,184.0
25.00%
7.10%
2015
$103,957.2
12.10%
68,611.7
66.00%
12.10%
10,395.7
10.00%
12.10%
25,989.3
25.00%
12.10%
2016
$114,352.9
10.00%
75,472.9
66.00%
10.00%
11,435.3
10.00%
10.00%
28,588.2
25.00%
10.00%
8612
344
8956
4.00%
5.20%
8956
336
9292
3.75%
5.50%
9292
325
9617
3.50%
5.60%
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 flexibility
a)
Allows WAG to return income to shareholders in the form of dividends
and stock repurchases
Slow store growth to free up capital and focus on WAG’s core
business
3. 2009 Repurchase Program
4. “2008 Rewiring for Growth” Program
2.
a)
b)
c)
5.
Enhance the customer experience (CCR)
Extend their presence in pharmacy, health and wellness services
Cost reduction and productivity gain
Reduce on-hand inventory
a)
Eliminate 3,500 products
Source:http://news.walgreens.com/article_display.cfm?article_id=5260
RESULTS
 Sustain long-term revenue growth
 Increase margins through cost reduction (“Rewiring for Growth”)
 2010 - $600 million cost reduction
 2011 - $1000 million cost reduction ($400 million net gains)
 Double digit EPS growth
 30-35% return to shareholders
 Low leverage allows WAG to compensate equity holders
Source:http://news.walgreens.com/article_display.cfm?article_id=5260
ROE
2010
61.99%
97.54%
5.13%
256.59%
182.47%
14.52%
Tax Burden
Interest Burden
Profit Margin
Asset Turnover
Leverage Ratio
ROE
2011
63.47%
96.81%
4.97%
260.51%
173.20%
13.79%
FORECASTED
2012
2013
63.47%
63.47%
97.55%
97.53%
5.96%
6.51%
258.25%
256.77%
172.50%
171.00%
16.43%
17.70%
2014
63.47%
97.69%
6.50%
252.00%
170.00%
17.27%
2015
63.47%
98.06%
6.90%
256.00%
169.50%
18.64%
2016
63.47%
98.36%
7.42%
254.41%
168.50%
19.86%
300.0%
254.4%
250.0%
200.0%
168.5%
150.0%
100.0%
98.4%
63.5%
50.0%
0.0%
2005
7.4%
2006
2007
Tax Burden
2008
2009
Interest Burden
2010
2011
Profit Margin
2012
2013
Asset Turnover
2014
2015
2016
Leverage Ratio
DEBT SCHEDULE
(WITHOUT OPERATING LEASES)
($ in millions)
Cash
Secured Debt
Revolving Credit Facility
Unsecured Debt
4.875% Senior Notes
5.250% Senior Notes
Variable Loans
Total Debt
CAPITALIZATION SUMMARY
Book
Interest
Value
Rate
Yield
Debt /
LTM EBITDA
Estimated
Interest
Maturity
Date
$2,087.0
0.0
L + .525%
0.0
Nov-11
1,294.0
995.0
57.0
4.88%
5.25%
NA
63.1
52.2
Aug-13
Jan-19
NA
$2,346.0
Preferred Stock
Shareholders' Equity
Total Capitalization
Debt/Capitalization
0.0
34,008.3
$36,354.3
6.45%
Cash
Revolver Availability
Total Liquidity
2,087.0
1,200.0
$3,287.0
.6x
$115.3
2009 CREDIT STATISTICS
2009 EBITDA
Capital Expenditures
2009 EBITDA / Interest Expense
(2009 EBITDA - Cap Ex) / Interest Expense
4,222.0
1,927.0
36.6x
19.9x
DEBT SCHEDULE
(WITH OPERATING LEASES)
($ in millions)
Cash
Secured Debt
Revolving Credit Facility
Unsecured Debt
4.875% Senior Notes
5.250% Senior Notes
Variable Loans
Operating Leases
CAPITALIZATION SUMMARY
Book
Interest
Value
Rate
Yield
Debt /
LTM EBITDA
Estimated
Interest
Maturity
Date
$2,087.0
0.0
L + .525%
0.0
Nov-11
1,294.0
995.0
57.0
4.88%
5.25%
NA
63.1
52.2
Aug-13
Jan-19
NA
2,024.0
NA
19,869.8
Total Debt
$22,215.8
Preferred Stock
Shareholders' Equity
Total Capitalization
Debt/Capitalization
0.0
34,008.3
$56,224.1
39.51%
Cash
Revolver Availability
Total Liquidity
2,087.0
1,200.0
$3,287.0
5.3x
$2,139.3
2009 CREDIT STATISTICS
2009 EBITDA
Capital Expenditures
4,222.0
1,927.0
2009 EBITDA / Interest Expense
(2009 EBITDA - Cap Ex) / Interest Expense
Although WAG doesn’t have much long-term debt, its operating leases make it a much
more highly levered company
2.x
1.1x
WACC – W/ OPERATING LEASES
Risk Free Rate (Rf)
2.46%
Beta
0.82
Market Risk
Premium
6.00%
Cost of Equity
(CAPM)
7.38%
Cost of Debt
5.25%
Tax Rate
36.53%
Cost of Debt (Aftertax)
3.33%
Weight of Equity
0.605
Wight of debt
0.395
WACC
8.63%
COST OF EQUITY
CAPM
COMBINED
ROE
7.38%
12.09%
16.79%
Cost of Debt
WACC
Cost of Equity
3.33%
8.63%
12.09%
Weight: 39.50%
Weight: 60.50%
DCF – W/ OPERATING LEASES
DCF ANALYSIS (WITH OPERATING LEASES)
($ in millions)
Forecasted FCF's:
Terminal Value
Discount Factor:
Discount FCF's
Shares Outstanding
Share Price
8.63%
4%
$40,359.1
22,215.8
18,143.3
977.25
$18.57
2
1,427.0
3
1,613.7
4
1,828.0
5
2,052.1
0.921
0.847
0.780
0.718
0.661
$1,974.2
$1,209.3
$1,258.9
$1,312.8
$1,356.8
6
2,326.7
52,296.9
0.609
$33,247.0
SENSITIVITY ANALYSIS (WITH OPERATING LEASES)
TERMINAL
GROWTH RATE
Discount Rate
Terminal Growth Rate
Enterprise Value
Net Debt
Equity Value
1
2,144.6
$18.57
2.5%
3.0%
3.5%
4.0%
4.5%
5.0%
5.5%
7.5%
17.93
21.62
26.23
32.15
40.05
51.10
67.69
8.0%
14.13
17.07
20.67
25.18
30.96
38.68
49.48
8.5%
10.96
13.36
16.24
19.76
24.15
29.81
37.35
WACC
8.63%
10.24
12.52
15.25
18.57
22.69
27.95
34.88
9.0%
8.28
10.26
12.61
15.42
18.86
23.16
28.69
9.5%
5.99
7.65
9.59
11.88
14.63
17.99
22.19
10.0%
4.00
5.41
7.03
8.93
11.17
13.86
17.14
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 price
 Any merger or acquisition in the industry could
provide stimulus to stock price
 Regular dividend paying stock
 Consistently outperformed both S&P 500 and DJIA