Walgreen Co.
(WAG)
Presented April 19, 2007
Investment Managers
Jessica
Boghosian
 jboghos2@uiuc.edu
Shengdong
Zhu
 szhu4@uiuc.edu
Company Overview





Incorporated in 1909, headquartered in Deerfield, Illinois.
Nation’s largest drugstore based on sales
Engaged in the retail sale of prescription and nonprescription drugs and general merchandise including:
beauty care, personal care, household items, candy,
photofinishing, greeting cards, seasonal items, and
convenience foods.
Recorded its 32nd year of consecutive earnings and sales
growth.
During the year, Walgreen Co. had a net increase of 476
stores, totaling to 5,461 stores located in 47 states and
Puerto Rico.
Company Overview
Success is dependent upon
continuously opening new Walgreens
stores.
 Walgreen Co. plans to operate more
than 7,000 stores by 2010.
 Walgreen Co. is in the business of
strategically locating new stores as
well as relocating/closing existing
stores.

New Walgreens Co. Stores

Fiscal Year
# of New Stores
2000
462
2001
474
2002
471
2003
430
2004
436
2005
435
2006
570
Over the past 7 years, Walgreen Co. has
opened on average 1.28 stores/day.
National Store Distribution

Walgreen Co. has made it a point to open the most stores
in the states that are the popular locations for aging baby
boomers to retire.
Image: Walgreen Co. Annual Report 2006
Product Class Attribution to Sales
Fiscal Year
2006
Fiscal Year
2005
Fiscal year
2004
Prescription
Drugs
64%
64%
63%
NonPrescription
Drugs
11%
11%
12%
General
Merchandise
25%
25%
25%
Pharmacy Sales



Pharmacy sales continue to become a
larger portion of Walgreens’ business.
Walgreens filled 529 million prescriptions in
2006, totaling to an increase of 8.1% from
the 2005 fiscal year.
Sales trends are expected to continue to
grow for the following reasons:



Aging population
Introduction of lower priced generics
Continued development of innovative drugs
Medicare Part D

Medicare Part D is a government initiated
program to subsidize the costs of
prescription drugs to individuals covered by
Medicare. Part D was implemented in
January of 2006.

Walgreens has obtained a larger share of
senior citizen patients due to this program.
• 35% of the prescriptions filled under this program
in the first eight months were new customers to
Walgreens.
New Developments



Dial-a-Pharmacist
 Available in 14 languages, this system allows
customers to discover where there is a
Walgreens pharmacist that speaks his or her
language.
Solar Power Usage
 100 stores utilize solar energy, making
Walgreens the largest retail user of this source of
energy.
Highway Signs
 A new federal law allows signs to be placed on
highways informing drivers of the location of 24
hour pharmacies. Several have already been
planted with many more to come.
Source: Walgreen Co. Annual Meeting, January 2006
Corporate Risk

Walgreen Co. faces intense competition with
local, regional, and national companies, many
of which are infiltrating Walgreens’ existing
markets.


Extreme competition can have an adverse
affect on prices.
Third-party payors of prescription drugs are
attempting to reduce costs and pharmacy
reimbursement rates.

On February 8th, 2006, President Bush signed
the Deficit Reduction Act of 2005
• This Act will ultimately reduce Medicaid
reimbursement rates to retail pharmacies.
• Further reduction in these rates are foreseeable.
RCMP Position



Originally owned 1000 shares of WAG,
purchases on October 6th, 1999 for
$25.00/share.
On September 20th, 2006, 500 shares were
sold @ $49.94/share for a realized gain of
$12,470.
Currently own 500 shares of WAG, trading
at $45.96 as of April 19, 2007 for an
unrealized gain of $10,480 or 83.84%.
Role in Portfolio
WAG 7%
AEE 6%
SRZ 7%
AEO 19%
SRCL 5%
MVSN 1%
MS 9%
CPRT 9%
KMB 6%
FR 7%
JPM 14%
FR 7%
JKHY 3%

Walgreen Co. currently comprises 7%
of our portfolio.
Correlation Matrix
AEE
AEE
AEO
CPRT
FR
JKHY
JPM
KMB
MVSN
MS
SRCL
SRZ
WAG
Portfolio
AEO
CPRT
FR
JKHY
JPM
KMB
MVSN
MS
SRCL
SRZ
WAG Portfolio
1.00
-0.08
1.00
0.35
0.21
1.00
0.49
-0.02
0.36
1.00
0.17
0.40
0.38
0.21
1.00
0.32
0.47
0.45
0.15
0.55
1.00
0.30
0.08
0.47
0.14
0.31
0.22
1.00
0.21
0.44
0.33
0.20
0.57
0.51
0.06
1.00
0.17
0.50
0.39
0.11
0.46
0.68
0.15
0.57
1.00
-0.25
0.13
-0.08
-0.03
0.09
0.04
-0.07
-0.11
0.06
1.00
0.14
0.21
0.43
0.20
0.40
0.40
0.01
0.50
0.48
0.07
1.00
0.07
0.09
0.11
-0.18
0.02
0.16
0.26
-0.07
0.18
0.07
-0.17
1.00
0.33
0.63
0.66
0.34
0.74
0.78
0.35
0.76
0.76
0.11
0.62
0.15
1.00
5-Year Growth vs. S&P 500
Competitors

Who
CVS/Caremark Corp. (CVS)
 Rite Aid Corp. (RAD)


Why
Industry Specific
 Business Segment Specific
(prescription and non-prescription
drugs and general merchandise)

Out-performing Its Competitors
 Prescription
Volume
WALGREEN CO.
263/day
Chain Drugstores
180/day
Mass Retailers
143/day
Grocery
131/day
Independents
100/day
Source: Walgreen Co. Annual Meeting, January 2006
Out-performing Its Competitors
 Earnings
per square foot
WALGREEN CO.
$46
Chain Drugstores
<$23
Grocery
$12
Source: Walgreen Co. Annual Meeting, January 2006
1-Year Comparables
5-Year Comparables
Comparable Analysis
Qtrly Rev Growth (yoy):
Gross Margin (ttm):
EBITDA (ttm):
Oper Margins (ttm):
EPS (ttm):
P/E (ttm):
WAG
14.60%
28.08%
3.77B
5.97%
1.938
23.72
CVS
24.00%
27.25%
3.24B
5.57%
1.6
21.61
P/S (ttm):
ROA
0.9
11.82%
0.66
8.76%
RAD
Industry
-4.40% 12.30%
26.94% 25.26%
615.95M
1.70B
1.97%
3.79%
-0.009
1.6
3.44
26.95
0.2
3.53%
0.66
Assumptions
 Organic
growth continues to be the
primary growth vehicle
 Future growth was estimated assuming to
be in line with increasing medical costs
and increasing store numbers.
 We assume that future growth will
continue at a 13% annual rate but will
gradually decrease to 9% over the next
five years and then remain at a 3% annual
growth rate thereafter
Discounted Cash Flow Analysis
FY 2007 forecasted
Net sales:
Less:
Operating costs
Taxes paid
Net investment
∆
?
Working capital
= Free Cash Flow
FY 2009 forecasted
FY 2010 forecasted
53,164.21
64,610.11
70,276.59
(50,160.43)
(61,088.86)
(66,516.79)
(1,158.91)
(1,414.90)
(1,561.02)
(416.81)
(199.87)
(73.89)
881.04
1,052.47
1,338.22
1,428.06
1,906.49
2,124.88
Discounted Cash Flow Analysis




Since Walgreen Co. is 100% equity
financed, WACC=ke.
Beta: Regression 0.1 vs. Bloomberg .66
Average = .4
rf =
β=
r m=
ke=
4.77%
0.4
11.00%
7.26%
Discounted Cash Flow Analysis
Year
1
2
3
4
5
FY 2007 forecasted
FY 2008 forecasted
FY 2009 forecasted
FY 2010 forecasted Terminal Value
Free cash flow
Terminal Value
PV of FCFs
Total
Enterprise
Value=
1,428.06
1,331.35
1,665.55
1,906.49
1,447.61
1,544.81
2,124.88
1,605.18
51330.50475
36,150.11
42,079.06
Total enterprise
value over
Shares
outstanding
=Price Per Share
42,079.06
1,025.40
+ 10%
45.14
- 10%
36.93
41.04
A Note On Capital Structure


Walgreen Co. is an all equity financed firm.
The company owns a mere ~18% of it’s store
base. The other ~82% is leased.



These leases hold Walgreen Co. responsible for
$26.078 billion, but this obligation is not seen on
the balance sheet as a liability to the firm.
This poses potentially risk to Walgreen Co.
Lets call these lease obligations “quasi-debt.”

THEREFORE, it is important to keep in mind this
accounting structure when valuing WAG.
Sensitivity Analysis
WACC
Growth Rate
5.50%
6.00%
6.50%
7.00%
7.50%
8.00%
8.50%
9.00%
9.50%
3.00%
71.36
59.13
50.40
43.86
38.79
34.73
31.42
28.67
26.34
3.50%
88.09
70.07
58.07
49.51
43.10
38.12
34.14
30.89
28.19
4.00%
115.97
86.48
68.81
57.04
48.64
42.35
37.46
33.56
30.38
4.50%
171.73
113.84
84.92
67.58
56.03
47.79
41.62
36.82
33.00
5.00%
339.00
168.55
111.76
83.39
66.37
55.04
46.96
40.90
36.20
Most likely to range from 34.73 to 57.04
Portfolio Fit

Sharpe Ratio
a measure of the mean excess return
per unit of risk in an investment asset
or a trading strategy
 Including WAG generates a higher
Sharpe Ratio

Risk-free Rate
Sharpe Ratio (Include)
Sharpe Ratio (Exclude)
Month
0.2%
8.6%
8.1%
Annual
2.3%
31.1%
29.2%
RCMP Fall ’06 Decision

500 Shares of WAG were sold last
semester at $49.94. Why?

Lease Obligations
• WACC was adjusted upward based on
the risk of outstanding lease obligations

After this adjustment, the company
appeared to be trading at a
“significantly inflated price that, in the
long term, could not be sustained.”
Recommendation
 HOLD.
 Why?
•
•
•
•

Healthy management vision
Stable, growing company
Solid performer
Leader in its class
But what about these lease obligations
and other business risks!?
• Acknowledge that every company has risk,
with Wagreen Co. as no exception.
• We have already taken action as
conservative investors by selling 500 shares.