Walgreens charges on with expansion, despite tough fourth qtr.
DEERFIELD, ILL. —As the dust settles from an uncharacteristic earnings decline earlier this month at Walgreens, the view that’s left of the company is that of a retailer who remains committed to rapid new store growth, supplemented by acquisitions and expansion into new health care businesses.
Walgreens already fills nearly 17% of all retail prescriptions in the United States, and operated 5,997 stores at the end of its fiscal year on Aug. 31 after it opened a record 615 stores resulting in a net increase of 536 units. During its current fiscal year, the $54 billion company expects to invest $2 billion to open 550 new stores resulting in a net increase of 475 units, which puts it well ahead of a goal to operate 7,000 stores by 2010.
The increased selling space, combined with strong demand for prescription drugs, is expected to result in Walgreens’ annual sales approaching $60 billion by this time next year. But along the way, it will be two of the company’s newest growth initiatives that offer insight into its long-term strategy.
Earlier this year, two acquisitions revealed much about how Walgreens sees itself participating in the health care marketplace. In May, it acquired in-store clinic operator Take Care Health Systems, and in September it acquired Option Care, a specialty pharmacy and provider of home infusion services. Both deals provided a means for Walgreens to leverage its existing store base and provide consumers with a new range of service from a brand they trust.
The Take Care Health Systems subsidiary has already announced plans to open up to 100 new clinics in nine new markets by the end of the year, on top of its existing 63, with plans for a total of 400 clinics by the end of 2008. The new markets include Cincinnati, Cleveland, Houston, Las Vegas, Miami, Nashville, Orlando, Tampa and Tucson, on top of current markets Chicago, Kansas City, Las Vegas, Milwaukee, Pittsburgh and St. Louis. Clinics occupy about 250 square feet inside Walgreens stores.
“Our significant expansion plans underscore Take Care Health Systems’ vision to create a national footprint of clinics delivering access to high-quality, convenient and affordable health care to patients on their terms,” said Hal Rosenbluth, chairman of Take Care Health Systems and senior strategy consultant for Walgreens.
In addition to the in-store clinic initiative, Walgreens is looking to grow its specialty pharmacy and home infusion business. In September, the company completed the acquisition of Option Care, which has 100 pharmacies in 34 states. According to Walgreens, the specialty pharmacy industry is a $60 billion segment of the health care industry that aligns well with the home infusion business and its health care brand. As a result of the Option Care deal, Walgreens becomes the nation’s largest home infusion therapy provider and fourth-largest specialty pharmacy provider.
Despite the company’s various growth initiatives, and the fact that it just produced its 33rd consecutive year of record sales and profits, its fourth-quarter results were disappointing. In fact, it won’t be easy for Walgreens’ shareholders to forget the beating they took on Oct. 1 after a decline in fourth-quarter earnings caused the company’s stock to plummet. Walgreens shares lost 15% of their value that day, declining by $7.08 to $40.16 from the previous day’s close of $47.24 when the company revealed earnings per share for the fourth quarter ended Aug. 31 were 40 cents, a penny below prior-year results and well below analysts’ consensus estimates of 47 cents.
A large part of the discrepancy between Walgreens’ 4Q results and analysts’ expectations relates to the manner in which the company communicates with Wall Street. Walgreens doesn’t provide guidance around sales and profit growth. Executives routinely appear at investor conferences, but tend to speak in generalities about store expansion, growth opportunities and the size of potential markets. The company’s strong track record of consistent growth can cause expectations among the financial community to become elevated, while the policy of not providing guidance means exuberance grows unchecked.
For example, in early September when Walgreens president Greg Wasson spoke at an investor conference sponsored by Goldman Sachs, he and the company received a glowing endorsement from analyst John Heinbockel. “We continue to believe that investors should buy Walgreens shares as operating fundamentals remain robust,” Heinbockel said during his introduction of Wasson. Shares that day opened at $45.20, which Heinbockel said was the lowest valuation in a decade and made the company a suitable investment for those seeking a growth company well positioned for a slowing consumer spending environment.
Although the company’s fiscal year had ended six days earlier, Wasson offered no indication of how severely increased expenses and reduced generic drug reimbursement rates would eat into the financial results announced on Oct. 1. Heinbockel was among those whose view of the company changed that day, downgrading it to neutral from buy, and said investors seeking what he called “defensive growth” would be better served owning CVS/Caremark.
Beyond substantially missing earnings estimates, the profitability issue raised concerns about management’s ability to address known issues within the drug store industry. “Since reimbursement pressures from generics have been an ongoing industry issue since June 2006, we were surprised to see the significant impact on Walgreens results,” said Citigroup analyst Deborah Weinswig.