Healthy Profits at Walgreen

Results top estimates amid growth in sales of higher-margin generic drugs.
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looks quite healthy after beating Wall Street estimates for the third quarter in a row.

The giant drugstore chain on Monday posted third-quarter profits of $561 million, up almost 20% from a year ago, with soaring sales of high-margin generic drugs boosting the company's results.

Excluding favorable gains, the company's earnings per share of 54 cents topped analysts' average expectation by a penny.

Total revenue for the quarter ended May 31 rose 13% to $13.7 billion, but it fell a bit shy of Wall Street's estimate of $13.79 billion due to rising sales of cheap -- but extremely lucrative -- generic drugs.

Prescription sales, which account for two-thirds of Walgreen's business, jumped 14% in the latest quarter.

Total same-store sales, representing sales at drugstores open more than a year, rose 7.8% in the quarter, while front-end same-store sales rose 5.6%. The company posted market-share gains in 56 of its top 60 "front-end" product categories to boot.

Nevertheless, Walgreen's stock recently was down 41 cents to $44.56 a share.

Based on recent company updates highlighting the boom in generic sales, Wall Street was already looking for strong results from the drugstore chain. Earlier this month, in fact, several analysts raised their earnings estimates for the company in anticipation of yet another upside surprise. Some of them urged investors to buy the company's stock, which they view as unusually cheap, ahead of this week's report as well.

"While this is the lowest level of pharmacy comp-store dollar growth in over a year, Walgreen reported figures are being depressed by the increased penetration of generics," William Blair analyst Mark Miller stressed in early June. Meanwhile, "Walgreen's relative price-to-earnings premium

vs. the S&P 500 on 2007 earnings has not been this low since 1996.

Thus we reiterate our outperform rating on Walgreen and recommend investors build positions at current valuation levels."

A member of Miller's family has taken a long position in the company's stock already.

SunTrust Robinson Humphrey analyst David Magee views Walgreen's stock as a bargain investment, too. Indeed, Magee feels that now is an ideal time to buy the shares.

"Walgreen is a good hedge against higher inflation ... and interest rates

because Walgreen has no debt," Magee explained last week. "And with 65% of the business coming from the highly resilient pharmacy, it is also a good hedge against any slowing in the economy."

Magee has a buy recommendation and a $55 price target on Walgreen's shares.

Bear Stearns analyst Robert Summers feels more cautious. He, too, predicted that Walgreen would beat Wall Street targets yet again -- in fact, he questioned why those targets were so low -- but he warned of a looming slowdown ahead.

"We are reluctant to afford the current earnings cycle a premium multiple, as growth appears to be peaking," Summers wrote on Thursday. "We question how Walgreen will replace margin gains from generics when

the rate of substitution begins sharp deceleration by

fiscal 2009. In our opinion, the compressing multiple ... reflects some caution regarding earnings trajectory beyond

fiscal 2008."

Summers has a market-weight recommendation on Walgreen's stock in the meantime. His firm has non-investment banking ties to the company.