Walgreen’s (WAG) and Target (TGT) have been in the news quite a bit as of late–Walgreen’s bowing to political pressure from the proposed ban on tax ‘inversion deals’ and Target as a result of its delayed disclosure of the magnitude of its credit card data breach. Both items have been a major distraction to the respective executive suites, and it is starting to show.
In the case of Walgreen’s, the CFO and pharmacy chief lost their jobs today, in part as a result of a ~$1 billion forecasting error related to its prescription-drug business. Though the revision is not an act of illegal wrongdoing (companies change forecasts all the time), the revision is still an embarrassment for the company, especially in light of its decision to not relocate overseas amid political pressure. Peer CVS Caremark (CVS) had to make no such adjustment as it relates to generic drug pricing, the variable driving the change at Walgreen’s. A lack of focus and conviction in the executive suite at Walgreen’s seems evident.
Walgreen’s is not alone. Target released disappointing second-quarter results today, further revealing the prolonged impact of the credit card data breach. US segment transactions declined 1.3% in the second quarter, while adjusted earnings per share of $0.78 fell more than 20% from the same period a year ago. Management indicated that traffic trends continue to recover and monthly sales are improving, noting that July sales advanced 1%. Still, credit card data breach expenses and investments to grow its nascent Canadian business are weighing on earnings. Target now expects full-year 2014 adjusted earnings per share of $3.10-$3.30, compared with prior guidance of $3.60-$3.90. The foray into Canada has been costly, but sales increased 60%+ in the period, albeit off a small base.
As Walgreen’s and Target continue to navigate distractions, the dollar store industry is consolidating. Dollar General (DG) has made an overture to acquire Family Dollar (FDO), bidding over the top of Dollar Tree (DLTR), after indicating it had no interest just a few weeks ago. Dollar General’s proposal to acquire Family Dollar for $78.50 per share values the transaction at $9.7 billion. The deal will secure the combined entity as the largest small-box discount retailer in the US. We expect to update the reports with the buyout information shortly. Carl Icahn (IEP) has been the catalyst for the combination.
We don’t expect Target or Wal-Mart (WMT) to get involved in any bidding war for Family Dollar’s assets, though we’re not ruling out Wal-Mart scooping up the combined entity or Dollar Tree at some point in the future. Wal-Mart’s US same-store-sales growth was flat for the 13-week ended Aug 1, and the company lowered its full-year 2014 earnings-per-share guidance to the range of $4.90-$5.15 per share (was $5.10-$5.45) when it reported second-quarter results. Wal-Mart is losing share in the US, and it may eventually become acquisitive to solve such a problem while reducing pricing competition.
Valuentum’s Take
Despite the lingering distractions at Walgreen’s and Target, we fully expect both firms to recover. We’re not rushing to add either to the Best Ideas portfolio or Dividend Growth portfolio, however, though both are Dividend Aristocrats. We generally prefer firms currently included in the portfolios. Wal-Mart is also a Dividend Aristocrat. At the time of this writing, Walgreen’s is yielding 1.7%, Target is yielding 3.6%, and Wal-Mart is yielding 2.5%.
We think dollar-store consolidation has likely played out in the near term, though we’re watching and waiting for Wal-Mart to become acquisitive once valuations become amenable. We’re not rushing to add Dollar General or Dollar Tree to the Best Ideas portfolio, and we think any further bidding upside in Family Dollar is limited.
Related Firms: PTRY, CASY, BIG
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