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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Complaint Alleges Walgreens Executive Violated Ethics Laws

An executive of Walgreen Co. abused his position as the Indiana Board of Pharmacy (IBOP) President to help gain approval for a controversial Walgreens pharmacy model called “Well Experience,” an ethics complaint filed today alleges.

Change to Win (CtW) Retail Initiatives and Common Cause Indiana filed the complaint with the Office of the Inspector General.  The watchdog groups charge that Ethics Code violations by Walgreens Manager of Pharmacy Affairs Bill Cover and pharmacy board staff corrupted the regulatory process and led to the board approving a pharmacy format that creates risks to public health and patient privacy.

Indiana law prohibits state appointees from participating in decisions in which they or their employer have a financial stake in the outcome.  Heavily redacted e-mails obtained through the state’s Access to Public Records Act show that Cover was central to the Board’s Well Experience decision-making process and that he used his position on the board to secure special privileges for Walgreens.

The e-mails illustrate inappropriate involvement in the approval process including: Cover’s collaboration with IBOP staff to provide information from Walgreens to other board members; his deliberation on regulatory issues regarding Well Experience with the board’s executive director; and his solicitation of board members’ concerns before any public discussion about Well Experience.

According to the complaint, Cover and the board improperly kept the approval process from public view. The board held secret meetings with Walgreens management in Illinois deliberately arranged to circumvent Indiana laws requiring open meetings.

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