Updated from 9:53 a.m. ESTShares of Walgreen ( WAG) fell after the company reported that second-quarter profit missed analysts' estimates by a penny, while net income rose 17%, thanks partly to strong pharmacy results. The company earned $433.5 million, or 42 cents a share, in the quarter ended Feb. 29, compared with $370.9 million, or 36 cents a share, a year ago. Excluding gains from a litigation settlement, the company said it earned $425.6 million, or 41 cents a share, up from the prior year's $370.7 million, or 36 cents a share. On that basis, analysts were calling for 42 cents a share. Walgreen shares were recently down $1.21, or 3.6%, to $32.30. Tom Goetzinger, an analyst who covers Walgreen at Morningstar, said: "People have high expectations for their performance," he said. "If you ignore the bottom line EPS number, Walgreen is doing a pretty good business." Goetzinger added: "All in all, it was a good quarter. I'm not disappointed." (Morningstar does not do investment banking.) Total sales in the second quarter increased about 16% to a record $9.8 billion, while same-store sales rose 11.5%. The company said inventories were up 11% compared with a year ago. Deerfield, Ill.-based Walgreen said prescriptions made up 60% of sales in the quarter and total prescription sales rose 19%. Prescription sales in comparable stores rose 15.5%. "Even with these gains, our pharmacies are poised for more growth as the population ages and the Medicare prescription drug benefit begins," said Walgreen Chairman Dave Bernauer. Front-end same-store sales increased 6.2%, the company said on a prerecorded conference call. Gross profit margin in the quarter fell 14 basis points to 27.66 as a percentage of sales, vs. 27.8 a year ago. Walgreen said on the call that gross margin was hurt by a bigger amount of sales coming from lower margin pharmacy items and by fewer new generic prescription products introduced in 2004.
Goetzinger thinks investors could also be focusing on the company's gross margin decline. Much like what the company said, the analyst noted Walgreen's ratio of prescription-drug sales to front-end sales, which tends to makes gross margin low, an aspect that will likely be a constant for the company, said Goetzinger. Selling, occupancy and administration expenses increased 4% in the quarter to 20.74% of sales. The company said it had 1,250 24-hour stores at the end of the quarter, up 25% from a year ago. Merrill Lynch analyst Mark Husson said the increased spending to open more 24-hour stores during the quarter, as well as higher payroll expenses, affected the bottom line. He also cited higher insurance costs. But Husson thinks more 24-hour stores will be beneficial down the road. "The investment in 24-hour and expensive 'prime' new store locations, while moderately painful upfront, will provide a longer-term benefit," the analyst said in a research note, and lowered his full-year 2004 EPS estimate to $1.29 a share, from $1.30 a share. Wall Street's consensus is for $1.30 a share. Husson thinks an improved drug pipeline and more generic drug introductions will be positives the second half of the year. He also noted that "investors should start discounting the Medicare drug benefit in the near future." Walgreen opened 140 new stores in the first half of 2004, and said it plans to open 450 new stores in all of 2004. Walgreen had a total of 4,336 drugstores as of Feb. 29. The company stressed that investing in new stores, technology and equipment, and customer service initiatives are keys for its future growth. "We're in one of the most attractive retail segments, with an aging population driving an increasing need for our products and pharmacy services," the company said.