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Investors Shun Bed Bath & Beyond, Walgreens Growth Deals

In buying Cost Plus, Bed Bath & Beyond will take ownership of new private label brands and designs, and a business that has returned to profitability after the recession.

Cost Plus generates 68% of its sales from exclusively branded and sourced products, meanwhile, the company's foods selection may give Bed Bath & Beyond stores a feel akin to Williams Sonoma (WSM) and a selection that's similar to Whole Foods (WFM) and Trader Joes.

"Our Buy thesis on BBBY is predicated upon several drivers including square footage growth, share gains through traffic increases, organic operating margin gain opportunities and free cash flow generation," wrote Deutsche Bank analyst Mike Baker, in a Thursday note reiterating a $75 price target. "[We] believe the pending Cost Plus acquisition has several merits which could help drive upside to estimates," added Baker, who sees the deal adding 10 cents to 2012 earnings per share.

Even some analysts who took Bed Bath & Beyond's earnings as cause to cut earnings and price target estimates remain long-term bulls on the company's strategy. "We advise clients to keep in perspective that trends at BBBY slowed and did not fall off a cliff," noted Oppenheimer analyst Brian Nagel, who cut the company's 2012 earnings estimates slightly and its price target to $80 from $84. Nagle maintains an outperform rating based on the company's long-term outlook.

On Tuesday, Walgreens (WAG) shares slumped to 52-week lows after the nation's largest drug store chain acquired a 45% stake in Alliance Boots, in an international growth plan to hit back at competitors Express Scripts (ESRX - Get Report) and CVS Caremark (CVS - Get Report), who are expected to take market share in the U.S.

Amid a contract standoff with Express Scripts and expected market share losses in the consolidating U.S. market, Walgreens mapped out how England-based Alliance Boots will add to its earnings and transform the company into an international pharmacy powerhouse with a top presence in the U.S. and Europe. Shareholders and analysts didn't buy the plan, dumping the company's stock to one-year lows below $30.

But amid calls for a focus on share buybacks and a resolution to its dispute with Express Scripts, Walgreens may be vindicated for finding a differentiated growth strategy, while using attractive interest rates to venture abroad when few C-suites have the nerve to do so.

Walgreens highlighted that the deal could add up to 27 cents to its earnings per share when the deal closes and $1 billion in cost savings through 2016, in a projection that was affirmed by analysts.

"The synergy numbers are very real," said GAMCO Investors analyst Jeff Jonas, in a telephone interview. Still, Jonas questions whether the move will offset U.S. revenue losses were it to lose its Express Scripts and Medco business. He would have rather seen the company use its cash for share buybacks and to eat the costs of a settlement.

On Tuesday, Walgreen suspended a $4 billion share buyback program, but said it would increase its quarterly dividend to 27.5 cents per share from 22.5 cents.

In spite of a generally negative reaction to the deal, Walgreens may benefit from low interest rates and skepticism that Alliance Boots can continue to grow its earnings. "The deal can be EPS and value accretive, without stretching on synergies or underlying growth," wrote UBS analyst Jason DeRise in an analysis of the deal.

DeRise assumes that Walgreens will only achieve half of the $1 billion in cost savings - citing skepticism on the execution on revenue synergies - while forecasting a slowing of Alliance Boots earnings growth to 2% from a five-year growth rate of 13% on an expected European healthcare spending slowdown. "While the deal is not an easy win, we do not need to stretch our assumptions to find the deal creating value for shareholders," DeRise adds.
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