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Walgreen Co. (WAG - Analyst Report) reported adjusted net earnings of 73 cents per share in the fourth quarter of fiscal 2013, a 15.9% improvement from the year-ago adjusted net earnings of 63 cents. Earnings were in line with the Zacks Consensus Estimate.

On a reported basis, earnings came in at $657 million or 69 cents per share, better than the year-ago earnings of $353 million or 39 cents.

For fiscal 2013, adjusted net earnings rose 6.5% to $3.12 per share from $2.93 in the year-ago period but missed the Zacks Consensus Estimate by a penny. Reported earnings increased to $2.5 billion or $2.56 per share for the fiscal year, compared with $2.1 billion or $2.42 generated in fiscal 2012.

WAG’s sales came in at $17,941 million in the quarter, up 5.1% year over year and almost in line with the Zacks Consensus Estimate of $17,948 million. For fiscal 2013, sales increased 0.8% to a record $72,217 billion, which is also in line with the Zacks Consensus Estimate of $72,257 million.

Quarter in Detail

Front-end comparable store (those open for more than a year) sales along with basket size grew 1.6% and 3.6%, respectively in the fourth quarter. On the other hand, customer traffic in comparable stores declined 1.9%. Overall, comparable store sales improved 4.6% in the reported quarter.  

Prescription sales (accounting for 63.9% of sales in the quarter) climbed 6.1% compared with the prior-year quarter, while prescription sales in comparable stores increased 6.4%. Moreover, Walgreens filled 203 million prescriptions (up 8.2% year over year) during the reported quarter. Prescriptions filled at comparable stores grew 7.1%. Walgreens’ market share in retail pharmacy improved 40 basis points (bps) to 19.1% in the quarter.

Gross profit increased 7.4% year over year to $5.19 billion. As a result, gross margin expanded 60 bps to 28.9% on the back of higher generic prescription drug sales, partially offset by slightly soft margin in front-end sales. After excluding the benefit from LIFO, adjusted gross profit improved 4.3% to $5.18 billion.

Adjusted selling, general and administrative (SG&A) expenses rose 1.5% to $4.19 billion, However,  adjusted operating margin (excluding equity earnings in Alliance Boots) during the quarter expanded 60 bps to 5.5%.

Walgreens’ Balance Rewards loyalty program (launched in Sep 2012) has recorded more than 85 million registrations to date. The company opened/acquired 33 stores in the reported quarter compared with 54 stores in the year-ago quarter. In fiscal 2013, it has opened 186 new drugstores, out of which 76 were acquired.

As of Aug 31, 2013, the company operated in 8,582 locations in 50 states, the District of Columbia, Puerto Rico and Guam, including 8,116 drugstores (186 more compared with the year-ago period). The company also operates infusion and respiratory service facilities, specialty pharmacies, mail service facilities, and e-commerce business.

Financial Condition

Walgreen exited the fourth quarter with cash and cash equivalents of $2.1 billion, significantly higher than $1.3 billion as of Aug 31, 2012. Long-term debt was higher at $4.5 billion in the reported quarter, compared with $4.1 billion as of Aug 31, 2012.

Moreover, the company has generated operating cash flow of $4.3 billion and record free cash flow of $3.1 billion in fiscal 2013. It is worthwhile to note that the company has returned more than $1 billion to its shareholders via dividends.

Strides on Synergy Track

Walgreens’ partnership with Alliance Boots is yielding positive results, with combined first-year synergies of $154 million, which exceeded its expectation of $125 million–$150 million. The Alliance Boots deal was accretive to adjusted earnings by 8 cents in the reported quarter, in line with management’s expectation.

Walgreen and Alliance Boots’ strategic long-term relationship with AmerisourceBergen Corp. (ABC - Analyst Report) is also moving ahead, with Walgreens and AmerisourceBergen implementing their 10-year agreement for pharmaceutical distribution last month. Moreover, the three companies will collaborate on global supply chain opportunities. Additionally, Walgreens and Alliance Boots together have rights to buy a minor equity stake in AmerisourceBergen.

Walgreens and Express Scripts Holding Co. (ESRX - Analyst Report) together launched the Smart90 program, which is designed to supply medication to patients with chronic diseases for 90 days at a lower cost.

New Deals

In the reported quarter, Walgreens and Theranos, Inc. entered into a long-term partnership, whereby the new lab testing service of the latter will be available throughout the wide network of Walgreens’ pharmacies.

Further, WAG inked a definitive agreement to acquire certain assets of privately owned regional pharmacy chain Kerr Drug, including 76 retail drugstores and specialty pharmacy business. The acquisition also includes a distribution center.

Despite these accretive strategies and milestone achievements, Walgreen’s moderate fourth quarter results, with in-line results at both fronts, failed to impress us. The company has a Zacks Rank #3 (Hold).

While we choose to remain on the sidelines regarding WAG, drug retailers like Herbalife Ltd. (HLF - Snapshot Report), carrying a Zacks Rank #1 (Strong Buy), is worth considering.

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