Walgreen Remains Neutral

Recently, we have reiterated our Neutral recommendation on Walgreen (WAG - Analyst Report) with a target price of $31.00.

Walgreen reported EPS of 62 cents per share in the third quarter of fiscal 2012, lagging the year-ago earnings by 3 cents but in line with the Zacks Consensus Estimate. As expected, the termination of the Express Scripts (ESRX - Analyst Report) contract took its toll on Walgreen with a negative impact of 6 cents per share on the bottom line.

Also, the company incurred a charge of 1 cent per share associated with the latest agreement with Alliance Boots GmbH, a global international pharmacy-led health and beauty group. Total sales were $17.8 billion in the third quarter, down 3.4% year over year and nominally missing the Zacks Consensus Estimate of $17.9 billion.

In order to negate the impact of the Express Scripts contract loss, Walgreen has been taking a number of strategic steps to drive growth. In June 2012, the company entered into a strategic partnership to buy 45% stake in Alliance Boots GmbH. Jointly they expect to form the world’s first pharmacy driven health and wellbeing retail with more than 11,000 stores in 12 countries.

Walgreen expects this transaction to be accretive to its EPS by 23 –27 cents in the first year. The company also expects the synergies across joint operation to be between $100 and $150 million in the first year and $1 billion by the end of 2016.

Earlier, in May 2012, the company acquired certain assets of BioScrip's (BIOS) community specialty pharmacies and centralized specialty and mail service pharmacy businesses that include a national network of 30 locations in 16 states across the US and the District of Columbia, primarily serving HIV, oncology and transplant patients.

The acquisition fits Walgreen’s strategy to expand community pharmacy and bring additional specialty pharmacy products and services closer to patients. Moreover, leveraging on its strong cash balance, the company has rewarded its shareholders and is also well equipped to pursue suitable acquisitions going forward.

Although the client retention rate in fiscal 2012 is expected to be at 97%–99% of fiscal 2011 prescription volume, the non-renewal of the Express Script contract will remain a major headwind. Walgreen has also been impacted over the past few quarters by high unemployment levels and lower discretionary spending.

Our recommendation is backed by a Zacks #3 Rank (Hold) in the short term.