Why Walgreen Might Not Be Worth the Investment

NEW YORK (TheStreet) -- Shares of Walgreen (WAG) have fallen 11% over the last month on  the news of its plan to purchase the remaining equity it doesn't already hold in Alliance Boots for $15.3 billion. It will not use this acquisition to move aboard and seek a tax inversion.

In addition, the company revised down its revenue guidance of the combined entity to an average of $128 billion and adjusted earnings per share of $4.43. This represents a 20% cut in its guidance. This sharp fall in the stock could make the company appealing at $61.1 per share, but its current valuation is still high compared to CVS Caremark (CVS) .

At $61, Walgreen shares are up over 6% for the year to date and up 25% over the last year. CVS shares, at around $79, are up 11% YTD and 35% for the past 52 weeks.

Walgreen's decision not to leave the U.S could have saved $4 billion in taxes over the next five years, according to analysts. But the company's market cap has contracted by nearly $10 billion since the company's announcement, which suggests this decision to remain in the U.S was already priced into the company's stock.

In addition, Walgreen plans to repurchase $3 billion of its stocks by 2016 and pay a 34 cents quarterly dividend. These steps could boost the company's augmented dividend yield, which includes its divided yield and buyback yield (the company's shares repurchase program divided by its market capitalization) to roughly a 4% annual yield.

According to Walgreen CEO Gregory Wasson, the decision to remain in the U.S wasn't due to political pressure but to avoid additional risk from implementing the tax inversion including battling the U.S. Internal Revenue Service and paying back taxes.

The company has also undergone a shakeup, with CFO Wade Miquelon leaving the company and pharmacy chief Kermit Crawford retiring at year's end, reportedly because of a billion-dollar forecasting error in the company's Medicare-related business.

The company is also behind CVS Caremark in offering in-store clinics to take advantage of the increased number of people seeking preventive care thanks to insurance coverage under the Affordable Care Act.

By one measure Walgreen's stock remains high. Its forward P/E is at 16.59, while CVS Caremark's P/E is 15.66. This measure suggests Walgreen's stock is more expensive than CVS Caremark.

Walgreen's enterprise value (market capitalization plus debt minus cash)-to-Ebitda (earnings before interest, taxes, depreciation and amortization) ratio is expected to pick up next year to 10.2 as the Alliance Boots deal will close in the first quarter of 2015. This fiscal year this ratio is projected to reach 9.8.

Moreover, CVS Caremark also has higher growth in sales and wider profit margins. In the past quarter, CVS Caremark's revenue grew by over 10% and its operating profit was around 6.4%. Walgreen's net sales rose by only 6.4% and its profit margin was 5.2%.

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 several positive factors, 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 low profit margins."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • The revenue growth came in higher than the industry average of 4.8%. 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 ($3.30 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.
  • The stock has not only risen over the past year, it has done so at a faster pace than the S&P 500, reflecting the earnings growth and other positive factors similar to those we have cited here. Looking ahead, the stock's rise over the last year has already helped drive it to a level which is relatively expensive compared to the rest of its industry. We feel, however, that the other strengths this company displays justify these 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.

At the time of publication, the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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