NEW YORK (TheStreet) -- Walgreens' (WAG) decision not to pursue a tax inversion in Switzerland after it buys the British chain Alliance Boots surprised the market and caused the stock to plunge over 12.6% in a day, to $60.42 as of 10:30 a.m.
At the same time arch-rival CVS Caremark (CVS) announced earnings that disappointed some as its recent decision to stop selling cigarettes bit into profits. Pharmacy sales saved the company, however, and the stock was down only 0.21% to $77.10.
While CVS and Walgreens may appear to be similar, in fact they are quite different -- and growing more so. CVS also owns Caremark, a pharmacy benefit manager, which handles drug sales and bookkeeping for large corporations. Walgreens doesn't have a PBM, but it's going to have a big European presence once the Alliance purchase is complete, and it already holds a 45% stake in the British company.
While both chains have said they want to emphasize clinics staffed by nurse practitioners to handle routine care, CVS has been more aggressive. It now has over 800 MinuteClinics in more than half the states, double the number of Walgreens Healthcare clinics.
The two also differ in how they fit the new model of care into existing stores. CVS is maintaining the look and feel of a convenience store with a pharmacy counter. Walgreens is spending about $1 million to remodel each of its stores under the name Well Experience. It has run into criticism for letting pharmacists come out from behind their counter in the new units.
Alliance Boots will transform Walgreens' numbers even in absence of a headquarters change, because it has over 3,100 units along with its own private label products.
After the merger, the Walgreens and Alliance Boots chains together will have over 11,000 units, against 7,600 for CVS.
Combining the last reported yearly results, the Walgreens-Alliance merger would seem to create a company with $114 billion in annual sales -- larger than Costco (COST) or Kroger (KR) -- with profits of about $4.7 billion and nearly $7 billion in operating cash flow each year. (This is a back-of-the-envelope calculation, and real numbers will vary once the deal is in place.)
Compare that to CVS' $126 billion in revenue, $4.6 billion in earnings and $5.8 billion in free cash flow last year. The merged Walgreens-Alliance and CVS are pretty comparable.
On an earnings basis, this makes CVS a relative bargain. Investors are paying a price-to-earnings multiple of 19.6 for its earnings, against 23.5 for Walgreens before last night. The fall of Walgreens stock killed $9 billion in market cap, leaving it with a valuation of about $57 billion, and putting the two companies' P/E back into balance.
Some of the earlier difference in valuation has to be based on the assumption that Walgreens would do a tax inversion. But some was also based on hope for synergies in the Alliance Boots merger.
Still, over the next year Walgreens is going to be a much more complicated company. The merger will create a mixed executive suite -- several Alliance executives will take prominent roles in the new company -- while CVS will remain undisturbed.
Even if you believe that Walgreens' redesign is going to work, and that it's going to result in customers staying longer and buying more non-drug items, the stock will likely be pulled down by euro-anxiety surrounding Ukraine.
While all this may result in a stronger Walgreens, the merger will take time to jell, and for now the stock has further to fall.
At the time of publication, the author was long WAG, although positions may change at any time.
This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
TheStreet Ratings team rates WALGREEN CO as a Buy with a ratings score of B+. TheStreet Ratings Team has this to say about their recommendation:
"We rate WALGREEN CO (WAG) a BUY. This is driven by a number of strengths, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its revenue growth, impressive record of earnings per share growth, compelling growth in net income, largely solid financial position with reasonable debt levels by most measures and solid stock price performance. We feel these strengths outweigh the fact that the company shows weak operating cash flow."
Highlights from the analysis by TheStreet Ratings Team goes as follows:
- The revenue growth came in higher than the industry average of 4.3%. Since the same quarter one year prior, revenues slightly increased by 5.9%. This growth in revenue appears to have trickled down to the company's bottom line, improving the earnings per share.
- WALGREEN CO has improved earnings per share by 15.4% in the most recent quarter compared to the same quarter a year ago. The company has demonstrated a pattern of positive earnings per share growth over the past year. We feel that this trend should continue. During the past fiscal year, WALGREEN CO increased its bottom line by earning $2.56 versus $2.42 in the prior year. This year, the market expects an improvement in earnings ($3.35 versus $2.56).
- The net income growth from the same quarter one year ago has exceeded that of the S&P 500 and greatly outperformed compared to the Food & Staples Retailing industry average. The net income increased by 15.7% when compared to the same quarter one year prior, going from $624.00 million to $722.00 million.
- Investors have apparently begun to recognize positive factors similar to those we have mentioned in this report, including earnings growth. This has helped drive up the company's shares by a sharp 36.85% over the past year, a rise that has exceeded that of the S&P 500 Index. We feel that the stock's sharp appreciation over the last year has driven it to a price level which is now somewhat expensive compared to the rest of its industry. The other strengths this company shows, however, justify the higher price levels.
- WAG's debt-to-equity ratio is very low at 0.23 and is currently below that of the industry average, implying that there has been very successful management of debt levels. Despite the fact that WAG's debt-to-equity ratio is low, the quick ratio, which is currently 0.61, displays a potential problem in covering short-term cash needs.
- You can view the full analysis from the report here: WAG Ratings Report