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Recently, we reiterated our ‘Neutral’ recommendation on drug retailer Walgreen Co. (WAG - Analyst Report) with a target price of $38.00.

Last Quarter Synopsis

Walgreen reported earnings of 39 cents per share in the fourth quarter of fiscal 2012, significantly below the year-ago earnings per share (EPS) of 57 cents. However, after considering the negative impact of 9 cents per share related to the Alliance Boots transaction, adjusted EPS came in at 48 cents during the quarter, significantly below the Zacks Consensus Estimate of 55 cents. For fiscal 2012, the company reported adjusted earnings of $2.53 per share, missing the Zacks Consensus Estimate of $2.59 as well as the year-ago earnings of $2.64 per share.

As expected, the termination of the Express Scripts Holdings Company (ESRX - Analyst Report) contract took its toll on Walgreen with a negative impact of 6 cents per share on the bottom line during the quarter and 21 cents per share during the fiscal year. Total sales for the fourth quarter and fiscal 2012, were $17.1 billion, (down 4.9% year over year) and $71.64 billion, (down 0.8%), respectively. Moreover, Walgreen has also been impacted over the past few quarters by high unemployment levels and lower discretionary spending.

However, we are encouraged with the settlement of the 7-month impasse between Walgreen and Express Scripts. The Express Scripts contract loss remained a major hindrance for the company since the beginning of 2012 as the earlier contract had contributed to a significant part of its sales (12.6% of total prescriptions filled in August 2011).

Although the company is leaving no stone unturned to compensate for the losses incurred since the termination of the previous deal, winning back clients remains crucial. However, to stimulate customers’ demand amidst a challenging macroeconomic scenario, Walgreen has been taking a number of strategic steps. This includes the launch of a customer loyalty program, ‘Balance Rewards', in September 2012. The company is also on an acquisition spree. Subsequent to acquiring a 45% stake in Alliance Boots GmbH for $6.7 billion, this leading retail pharmacy chain acquired a mid-South US-based regional drugstore chain for $438 million.

We believe these steps will help expand its business in several key regions of the nation.  Walgreen expects the Alliance Boots partnership to be accretive to its EPS by 23 – 27 cents in the first year. The company also expects the synergies across joint operations to be between $100–$150 million in the first year and $1 billion by the end of 2016. This new alliance is expected to form the world’s first pharmacy driven health and wellbeing retail with more than 11,000 stores in 12 countries. We are looking forward to all these new ventures of Walgreen and expect it to add to the company’s growth going forward.

Moreover, leveraging on its strong cash balance, the company rewarded its shareholders and is also well equipped to pursue suitable acquisitions going forward. Our long-term Neutral recommendation is backed by a Zacks #3 Rank (Hold) in the short-term.

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