WAG Meets Consensus and Tightens Its Belt

To see Brian Gilmartin's preview of the Walgreen earnings call, click here.

Walgreen(WAG Quote - Cramer on WAG - Stock Picks) reported 45 cents in earnings per share this morning (meeting consensus) and $14.597 billion in revenue (versus a $14.68 billion consensus estimate) for its fiscal fourth-quarter 2008 results, but the earnings number included a 4-cent vacation benefit accrual, so the true earnings of 40 cents were 10% below the consensus Street estimate.

Sales rose 9% year over year while earnings -- after adjusting for the vacation accrual -- were flat year over year.

Overall comps rose 2.6%, pharmacy comps rose 2.8%, and front-end comps rose just 3.7%. According to our spreadsheet, this is the weakest quarterly front-end comp since May 2003. Other highlights:

• Gross margins fell 34 basis points year over year.
• WAG's operating margin rose 38 basis points year over year, thanks to a sharp improvement in SG&A, and against a very easy '07 SG&A comp.
• Net margins rose 4 basis points year over year, with no change in the effective tax rate.
• Sales grew 9% year over year while inventories grew 8%.
• WAG boosted the annual dividend from 38 cents to 45 cents per share.

WAG is lapping an easier year of earnings after its shocking downside surprise in October 2007, but this might be small consolation to the drugstore retailer, as it is being pressed by competition from both above (CVS(CVS Quote - Cramer on CVS - Stock Picks)) and below (Wal-Mart(WMT Quote - Cramer on WMT - Stock Picks), Costco(COST Quote - Cramer on COST - Stock Picks)), not to mention the less-than-robust consumer.

Walgreen provided more detail on the conference call about cutting new-store growth, which it announced earlier this year. Since it is highly unlikely that WAG won't get Longs Drug Stores(LDG Quote - Cramer on LDG - Stock Picks) in its bid, Walgreen looks as though it is following through on its initial response to the changing industry landscape, by cutting store growth. That should reduce SG&A, improve margins and boost free-cash-flow. WAG opened 561 new stores in fiscal 2008 and plans only 365 new stores in fiscal 2009, a pace that's roughly 35% below the former buildout.

Walgreen's is a changed business and a different company: The days of mid-to-high-teens annual earnings growth are history, and the company is looking at high-single-digit, low-double-digit earnings growth for the foreseeable future. The reduced store growth should boost free cash flow, and with WAG able to generate cash from operations currently, under $30 the stock gets interesting, given that it will be trading at 10 times cash from operations. WAG currently generates no free cash flow; this is similar to the position Wal-Mart was in until it reduced new-store growth and improved margins and comps.

Current estimates for fiscal '09 are looking for $2.47 per share -- or 13% expected annual growth -- in EPS, which will come down after this quarter's results.