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Jim Cramer's Action Alerts PLUS

Walgreens: Positive Quarter, New Rite Aid Deal Are the Right Prescription

By Jim Cramer and the AAP Team | 2017-06-29 11:11:53.0
Stocks in Focus: WBA, RAD, AMZN

Earlier this morning, Walgreens Boots Alliance (WBA) reported a top- and bottom-line beat for its fiscal third quarter, pushing its shares higher in early market trading. Revenue of $30.1 billion rose roughly 2.1% year over year and exceeded consensus of $29.7 billion. On a constant currency basis, sales were up 5.0% from third-quarter 2016. Adjusted earnings of $1.33 per share beat consensus of $1.30 and represented a 12.7% increase from the year-earlier quarter (14.4% on a constant-currency basis).

Before digging deeper into the quarterly numbers, a quick note on guidance and the Rite Aid (RAD) merger.

Looking ahead, Walgreens raised the lower end of its guidance and now expects fiscal year 2017 (ending August) earnings of $4.98-$5.08 per share (assuming stable exchange rates for the remainder of the year), exceeding consensus of $5.00 at the midpoint.

Walgreens also announced it would be terminating its pending merger with Rite Aid. Instead, the company will now look to acquire 2,186 Rite Aid locations, three distribution centers and other related inventory in phases for $5.175 billion in cash. It plans to convert these locations into Walgreens-branded stores over time. It expects to realize approximately $400 million in synergies within three to four years of closing the new agreement. The deal is expected to close within the next six months. The company has also authorized a $5 billion repurchase program.

The original merger agreement was most likely not going to receive government approval due to antitrust concerns by the Federal Trade Commission over Walgreens pharmaceutical business. With this new deal, Walgreens can work around regulations as it is purchasing about 48% of Rite Aid's stores instead. In addition, Walgreens will not be assuming any debt from Rite Aid. Walgreens management favors this new transaction, as CEO Stefano Pessina said they "...view this deal as being more attractive than the transaction it replaces..."

In our view, the new agreement with Rite Aid is a positive and the buyback program is in line with what we expected if the original deal was terminated. Remember, we did not consider the original merger agreement a key to our investment thesis. We believed that Walgreens could benefit if the agreement with Rite Aid was approved, or if it issued a share buyback. With this new outcome, however, it appears we are getting a little bit of both.

For the quarter, retail pharmacy U.S. sales were $22.5 billion, a 6.3% increase over last year's quarter. Same-store sales rose 3.7%. Adjusted operating margin was 6.5%, which was in line with a year earlier. However, adjusted operating income was up 5.9% to $1.5 billion.

The increase in sales was largely attributed to higher prescription volumes. In addition, retail prescription market share on a 30-day adjusted basis was 20.5%, an increase of roughly 110 basis points from the same time last year. This is the highest market share that Walgreens has ever reported.

Internationally, retail pharmacy sales were $2.8 billion, a 0.2% decrease on a constant currency basis versus the same quarter last year. Same-store sales were up 0.2% on a constant currency basis, and comp pharmacy sales were down 0.1% on a constant currency basis. This decrease was due to a decline in the U.K. because of a reduction in government pharmacy funding. Management was excited about opening its first store in South Korea in April, as the company is looking to pursue a strategy of expanding its retail presence in Asia.

Overall, this quarter's results were positive. Management continues to improve retail operational performance, which is designed to deliver a better customer experience, reduce working capital, and improve ongoing efficiencies. Free cash flow continues to increase due to inventory improvements.

As we look past earnings, our outlook will focus on how quickly Walgreens can realize synergies with the new Rite Aid deal, and its additional share repurchase program suggests the shares are undervalued in management's view.

We view the combination of the positive earnings and the new Rite Aid agreement to be beneficial for Walgreens. Although the retail industry has faced pressures from e-commerce, we do not think Walgreens is as exposed as others in the group due to its thriving pharmaceutical and health and wellness businesses.

In addition, management said that they do not believe Amazon (AMZN) is interested in its pharmacy space, and commented that if Amazon were, they would look for ways to partner with the online behemoth.

We believe today's announcements confirmed our thesis, and through the Rite Aid agreement, we will look for Walgreens to increase its presence in its core business.

Action Alerts PLUS, which Cramer manages as a charitable trust, is long WBA.

Trimming This Financial Name on Strength

We are not changing our long-term outlook in the company, but view this sale as a great chance to increase our cash for future opportunities.

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Action Alerts PLUS Holdings

Holdings 1

Stocks we would buy right now

Symbol % Portfolio
ABT 0.00896105169155338 Health Services
AGN 0.049354616370346646 Drugs
APA 0.03986094435438671 Energy
CMCSA 0.028412552066995497 Media
CSCO 0.03471786385489073 Computer Hardware
DHR 0.03565869146317212 Health Services
DXC 0.028651807914171906 Computer Software & Services
EZU 0.014830181665750078
FB 0.055223930387502715 Internet
GE 0.02329882641951847 Industrial
GOOGL 0.05165386506171195 Internet
KEY 0.013711200472801947 Banking
MMP 0.03105614513533546 Energy
NUE 0.0395228574380305 Metals & Mining
SLB 0.03395960686230088 Energy
SNA 0.037383726121314034 Industrial
TJX 0.044490544997250234 Retail
WFC 0.040901707289604086 Banking
XEC 0.031415028906100075 Energy
Holdings 2

Stocks we would buy on a pullback

Symbol % Portfolio
AAPL 0.043125535176221 Consumer Durables
ADBE 0.015503778897031355 Computer Software & Services
ARNC 0.01860895170746242 Industrial
C 0.03312441991269584 Banking
DOW 0.03187025916609303 Chemicals
LUV 0.020393432241479707 Transport
NWL 0.023224749128373467 Consumer Durables
NXPI 0.02212748500463058 Electronics
PEP 0.02545755831140747 Food & Beverage
SBUX 0.02575570790558115 Leisure
WBA 0.014290935794806324 Retail
WDC 0.013424829628027721 Computer Hardware