Walgreens (WAG) reported strong fiscal fourth-quarter results Tuesday that showed solid revenue and earnings expansion. However, the lack of progress on key contract negotiations with pharmacy benefit manager, Express Scripts (ESRX) left us a bit disappointed overall, to say the least. Nonetheless, our $34 fair value estimate for Walgreens remains unchanged at this time.
Walgreens’ fourth-quarter sales advanced 6.5% thanks to a 4.4% increase in comps (stores open for more than a year), while earnings per share increased over 16%, excluding an after-tax gain associated with the sale of its pharmacy benefits management business (adjusted net earnings increased 10.1% during the period). Prescription sales (nearly two thirds of revenue) jumped 5.7% during the quarter, as the number of prescriptions filled advanced 4% (3.4% on an apples-to-apples basis). Walgreens also revealed nice share gains through the course of 2011 and now accounts for 20% of the retail prescription market.
Though the quarterly results were strong, Walgreens indicated that contract negotiations with Express Scripts had fallen through, and the company will likely not be a part of the pharmacy benefit manager’s network beginning next calendar year. The existing deal with Express Scripts is not small potatoes and likely contributes $5 to $6 billion in revenue per year, or about 7% of Walgreen’s business (Express Scripts reimburses Walgreens for prescriptions). We think the lack of a definitive agreement will continue to be the source of concern for Walgreen’s stock — not only because of the pressure on this year’s (fiscal 2012) earnings but also because of the uncertainty regarding further loss of business with Medco (MHS). Express Scripts is seeking to merge with Medco to create the largest pharmacy benefits manager, and the latter may play hardball with Walgreens as well.
We remain on the sidelines with respect to Walgreens’ stock and would only become interested if the shares fell below $27 (the low end of our fair value range) on improving technicals.