For many retailers, 13% annual sales growth would be impressive. For
, that result has been somewhat disappointing.
That doesn't mean that investors and analysts are abandoning the stock, one of the pricier names in retail. But it does mean that they will be taking a close look before the bell Monday when the U.S.' No. 1 drugstore retailer posts its fiscal fourth-quarter report. Among the areas of interest: how the company did on its bottom line and its expansion plans for 2004.
Despite the sales slowdown, most investors seem pretty sanguine about the company's future. But with Walgreen shares trading at about 25 times projected 2004 earnings, anything disappointing in its results could shake the company's stock.
"I think the company's in a very good competitive position," said Tom Goetzinger, who covers the company for Morningstar. But Goetzinger, who has a hold rating on Walgreen's stock, added, "Just because a company is a great company -- which Walgreen's is -- doesn't make it a great stock." (Morningstar doesn't do investment banking and Goetzinger has no position in Walgreen.)
While rivals such as
have struggled with slow sales or slow store growth, Walgreen has chugged along. From 2000 to 2002, the company grew its sales at an annual rate of more than 16%, while increasing its earnings per share by 13% to 22% per year. Meanwhile, its store base has swelled from 3,520 stores at the end of its 2001 fiscal year to 4,227 at the end of August.
But this fiscal year had been mildly disappointing for the company. Through the first nine months of the year, sales were only up 13.1% over the previous year. Excluding one-time gains, the company's net earnings were up 14.6% from the first nine months of last year.
The company has seen its gross profit margin -- the difference between what it charges customers for its products and what it pays suppliers for them -- increase this year. But it has also seen a troubling rise in its operating costs.
After Walgreen posted its third-quarter earnings in June, Company CEO David Bernauer acknowledged that the company's results were below plan. The company's shares slumped on the news.
Walgreen's sales didn't improve much in its fourth quarter. In June, July and August, the company posted year-over-year sales gains of 14.4%, 13.7% and 14%, respectively. For its full fiscal year, the company posted sales growth of 13.1%.
Analysts surveyed by Thomson First Call estimated Walgreen's earned 27 cents a share in its fourth quarter on $8.24 billion in sales. Those figures represent 12.5% growth in earnings per share and 14% revenue growth.
Again, while those figures might impress most retail investors, they are off-pace for the drugstore chain.
Perhaps more troubling for Walgreen investors, the company's store growth slowed in 2003. Subtracting closed stores and relocations, the company opened a net 344 stores this year, slightly fewer than it had expected to open and fewer than it opened in 2002. The company has said it expects to open 450 stores in 2004, but did not say how many it planned to close or relocate.
"That's a key number for them: their real estate plan for 2004," said Goetzinger.
Also key will be how the company did in the fourth quarter on its expenses. Drugstore chains have been benefiting from a move toward generic drugs. While generics generally cost less than branded drugs, they tend to offer higher profit margins for retailers.
But that trend has been partially offset by the increasing dependence of drugstore chains on pharmacy sales. In general, sales of prescription drugs generally offer slimmer profit margins than the sales of over-the-counter medicines and general merchandise that constitute drugstores' so-called front-end revenue. For much of the last year, drugstores' growth in pharmacy sales has far outpaced that of their front-end sales.
Through the first nine months of this year, these opposing trends have been a net benefit for Walgreen. The company's gross profit margin increased 66 basis points through the first three quarters to 27.1% of sales.
Front-end sales picked up in August, growing 5% on a same-store basis over the same month a year ago. In contrast, such sales were growing at less than 2% earlier in the year. But one buy-side analyst, who asked not to be named, questioned whether that number was as good as it looked.
"How promotional did they have to be to generate that volume," wondered the analyst, whose company is long Walgreen .
While Walgreen's gross margins increased through the first part of 2003, so too did its operating expenses. During the same period, Walgreen's sales, general and administrative costs have risen 60 basis points to 21.3% of sales. The company has blamed that upsurge in part on its move to increase the number of 24-hour stores that it operates.
The buy-side analyst expects Walgreen's gross margin to start to decline as the trend toward generics slows. But the analyst hopes that the company's operating expense increase begins to moderate as well.
"What we're looking for is
information on their operating margin," said the analyst.
Longer term, the company could face a double threat from discounters such as
and mail-order pharmacies, the analyst said. Drugstore chains tout their convenience -- most are located much closer and tend to be easier to shop than the giant discount chains. But with drugstore prices typically higher on front-end goods than those at the discounters, the question is whether customers will continue to pay a premium for that convenience, the analyst said.
Meanwhile, depending on what happens with efforts in Congress to extend a prescription drug benefit to Medicare recipients, drugstores could see increased competition from mail-order companies that often get preference from insurers for filling chronic care medications.
Still, Walgreen's remains the top drugstore chain, and is likely to stay that way for some time to come, the analyst said. The big difference between Walgreen and its competition is that the company continues to grow at a rapid pace, analysts say.
"The stock is expensive," said the analyst. "But relative to the S&P, it's lower than it has been.
"I don't think it's a crazy multiple to pay at this point, if you assume they can continue