Walgreens Boots Alliance: Q1 2015 and the road ahead

The new Walgreens Boots Alliance enters 2015 as a transformed enterprise. Following the closing of Walgreen’s acquisition of Alliance Boots, the combined company faces high expectations and significant strategic challenges.

In the recent quarter, Walgreen posted a 12% jump in net profit due partly to cost-cutting and lower taxes, but the company’s gross margin remains under pressure, down a full percentage point over last year to 27.1 percent–the fifth continuous quarter of decline. Walgreen attributes this margin squeeze to rising generic drug prices, increased competition, and lower payments from insurers. In the front end, customer traffic continued to drop, while comparable store sales were nearly flat.

Some analysts have raised questions about whether Walgreen is overbought, with a higher proportion of “Hold” ratings than in the past:

Cantor Fitzgerald: U.S. gross margin outlook appears to be even more worrisome than we previously expected. Secondly, we think the stock is trading at pre guidance cut levels from earlier in the year at which time, a high probability of a tax inversion was also assumed. Even with the help of a lower tax rate and accelerated cost reduction efforts, we estimate EBITDA grew by just 2-3% in 1Q.

Bank of America: WAG stands to pay another $16 billion for the remaining 55 percent interest in Alliance Boots, a rich price tag for a significant balance sheet liability, a profit contribution that does not appear to be growing much, and an expected purchasing synergy that may not be sustainable. Despite the latest upside, we remain cautious on the profit expectations for the combined entity.”

Credit Suisse: We continue to rate WAG Neutral as we do not view the risk/reward favorably.  While management’s increased focus on mix, costs, and better use of the loyalty card makes sense, we have concerns about the company closing the margin gap to CVS, believe a front-end improvement will be difficult and take time, and see structural challenges longer-term in the standalone pharmacy business.

Walgreen management discussed some of its upcoming plans, including a $1 billion cost savings program, enhanced supply chain efficiencies, and synergies with Alliance Boots. Pharmacy margin pressure is expected to intensify in the second quarter, as Medicare Part D reimbursement rates step down and generic drug inflation headwinds persist.

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Walgreen 4Q earnings roundup

Walgreen Co. reported a fourth quarter net loss of $239 million, or 25 cents per share, compared with earnings of $657 million, 69 cents per share, for the same period last year. In the quarter, Walgreen absorbed an $866 million accounting charge from an early exercising of its option to buy the remaining 55 percent of Alliance Boots it does not already own. Excluding this event and other items, adjusted earnings-per-share were in-line with expectations at 74 cents, but despite meeting analysts’ expectations, there were few bright spots in management’s report. The benefits from Walgreen’s top line growth were largely offset by a significant reduction in gross margin.

Walgreen management discussed a number of issues that will continue to influence performance next year, including reimbursement pressure for prescription drugs, price inflation for generic medication and shrinking traffic on the store’s front end.

The earnings call comes a little over a month after the company shocked investors with a $2 billion forecasting blunder that cost two executives their jobs.

Following the difficult quarter, investors and observers are asking what the future holds for Walgreen.

Walgreen posts 4Q loss on Alliance Boots charge
Associated Press

No relief in sight for what ails Walgreen
Crain’s Chicago Business

Walgreen Profit Remains Pressured by Drug Price Miscalculation
Wall Street Journal

Higher generic drug prices, lower reimbursements to hurt Walgreen margins
Reuters

Walgreen suffers 4Q loss on acquisition charge
Chicago Tribune