The pharmacy company released anemic quarterly results last week showing margins dropped by more than 120 basis points.
Walgreen reported a year-over-year decline in net income to $754 million, or 78 cents a share, from $756 million, or 79 cents a share. Profit excluding items was 91 cents, 2 cents less than the consensus estimate of analysts polled by Thomson Reuters.
So why is the stock, currently trading around $66, up nearly 15% for the year to date? Because the company is still profitable.
Consider: The company is closing down 74 Walgreen's locations by this August, which can give a more than $40 million boost to its bottom line. Synergies coming from prior acquisitions and a healthy business environment could help the company sustain its above-average margin in the coming years.
In its previous quarterly results, Walgreen reported a 4.3% year-over-year growth in comparable-store sales and a 5.1% increase in net sales to a record level of $19.6 billion even though the company's earnings dropped by 1 cent to 78 cents per share from the same quarter last year.
The company suffered from fewer generic drug introductions, a moderate flu season and severe weather conditions that had an adverse impact on customer traffic. Nonetheless, Walgreen still managed to report higher sales and was able to improve its retail prescription market share by 20 basis points to 19%.
Walgreen has forecast the store closures could also give an annual boost of between $40 million and $50 million to the company's earnings before interest and taxes starting from 2015. Even with the closures, the company plans increase its total store count by between 55 and 75 locations by the end of the current fiscal year.
Unlike its other rivals, such as CVS Caremark (CVS), Walgreen has been all about profitability. The decision to close the stores was taken in light of Walgreen's efforts to optimize its cost structure and its assets.
In its previous quarter, Walgreen's gross profit margin dropped by 1.3 percentage points from the corresponding quarter last year to 28.8%. Last year, the company reported its results during the peak of the generic drug wave, which gave a boost to its margins. This year, the company witnessed the bottom of the generic drug wave. Moreover, an increase in promotional investments also dragged the margins.
Despite the drop in margin, the situation is not alarming. The company's profitability is still better than its historical average. Since FY2010, on an average, Walgreen has reported annual gross margin of 28.45%. The company is considerably more profitable than CVS Caremark, with an average annual gross profit margin of 19.3% in the corresponding period. Moreover, unlike Walgreen, CVS Caremark's gross profit margin shows a negative trend as they have fallen from 21% in FY2010 to 18.8% in FY2013.
Despite deteriorating margins, CVS Caremark has shown significant top-line growth. From FY2010 till the end of FY2013, CVS Caremark reported more than 30% growth in revenues. In the same period, Walgreen's revenues increased by just 7.1%.
However, when it comes to profitability, Walgreen is far ahead of the crowd. Walgreen's gross profit margin is considerably higher than the industry's average of 16.6%, according to data compiled by Thomson Reuters.
Walgreen's investment in Alliance Boots has generated synergies of $236 million in the first half of the current fiscal year. Walgreen is now eying synergies worth $375 million to $425 million in the second half, which is an improvement of $25 million from the previous estimate. By 2016, Walgreen is expecting to achieve synergies of $1 billion.
Moreover, positive secular trends, such as the expected increase in the elderly population by 45% by 2025 and the expanded medical coverage under the Affordable Care Act could fuel the company's growth in the long term.
By the end of fiscal year 2016, Walgreen is eying operating income of more between $8.5 billion and $9 billion from revenues of more than $130 billion. This would be a significant improvement from the previous fiscal year when Walgreen reported operating income of $4.47 billion from revenue of $72.2 billion.
This also implies that Walgreen could remain highly profitable. The low end of its 2016 target shows an operating margin of 6.54%, which would show an improvement from 6.19% in 2013. This is encouraging as the company's operating margin is already nearly twice as large as the industry's average of 3.22%, according to data compiled by Thomson Reuters.
At the time of publication, the author held no positions in any of the stocks mentioned.
This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.