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Tickers in this Article: RAD, ESRX, CVS, WAG
Drug retailer Walgreen Co. (WAG) posted dismal sales results for the month of September 2012, recording a decline of 7.8% year over year to $5.48 billion. Total front-end sales slipped 0.4%, while comparable store front-end sales were down 1.5%. Customer traffic in comparable stores fell 2.3% but basket size increased 0.8% year over year. Simultaneously, the number of prescriptions filled by patients reduced drastically.

Prescriptions filled at comparable stores of Walgreen decreased 10.3% [day-fall adjusted (DFA) 6.8%] for the month even with a 0.1 percentage point of positive impact due to higher incidence of 'flu in the month. Fewer 'flu shots in the month negatively impacted prescriptions filled by 0.4 percentage point. Additionally, one extra Saturday and Sunday in the month with one less Thursday and Friday, led to a negative impact of 3.5 percentage points on Walgreen's prescriptions filled.

Total sales in comparable stores decreased 11.1% in September. The decline was attributable to a decrease of 5.3 percentage points due to generic drug introductions during the last 12 months as well as the negative impact of 2.2 percentage points due to calendar day shifts. All these led to a 12.3% decline in Walgreen's total pharmacy sales which made up the lion's share (63.7%) of Walgreen's total sales in September.

Moreover, there was a 16.1% decline in comparable store pharmacy sales, 8.4 percentage points of which were due to the introduction of generic drugs in the last one year and a 3.5 percentage point impact from calendar day shifts. Flu shots administered at pharmacies and clinics season-to-date were 1.5 million down 16.7% year over year.

At the end of September, 2012, excluding the recent acquisition of USA Drug chain, Walgreen operated 8,400 locations in 50 states, the District of Columbia, Puerto Rico and Guam which includes 7,944 drugstores (167 more compared to the year-ago period). The company also operates infusion and respiratory service facilities, specialty pharmacies and mail service facilities.

Last Quarter Update

Notably last week, Walgreen released its fourth quarter and fiscal 2012 results (ending August 2012). The company reported adjusted earnings of 48 cents per share in the quarter, lagging the year-ago adjusted level of 57 cents per share. For fiscal 2012, the company reported adjusted earnings of $2.53 per share compared to $2.64 in the previous year.

The fourth quarter and fiscal 2012 sales were at $17.1 billion, down 4.9% year over year and $71.64 billion, down 0.8%, respectively.

Since January 2012, Walgreen has not been a part of the Express Scripts (ESRX) pharmacy provider network, which had an adverse effect on its sales throughout the earlier fiscal. This led to a negative impact of 6 cents per share (net off associated cost reduction) during the last quarter and 21 cents per share during the fiscal year.

However in July, Walgreen and Express Scripts entered into a new multi-year pharmacy network agreement per which, the pharmacy network of Walgreen has started filling prescriptions from Express Scripts customers from September 15, 2012.

Our Take

We certainly remain optimistic about Walgreen's renewed inclusion in the Express Scripts network. The company is bound to leave no stone unturned to compensate for the losses incurred since the termination of the previous deal. To stimulate customer demand amidst a challenging macroeconomic scenario, the company also launched a customer loyalty program 'Balance Rewards' effective September 16. Registrations for this loyalty program, totaled nearly 13 million in September.

We believe, with the resumption of the contract, sales are expected to improve, though winning back clients remain crucial. This is very much reflected in Walgreen's reduction in customer traffic during the month of September. There is also a lack of clear visibility with respect to the realization of synergies with Alliance Boots. The competitive landscape is also intense with players like Rite Aid Corporation (RAD) and CVS Caremark Corporation (CVS).

Walgreen currently retains a Zacks #3 Rank, which translates into a short-term 'Hold' rating. We maintain a long-term 'Neutral' recommendation on the stock.

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