Recommendation: Buy Target Price August 31, 2016: $77.57 1. Reasons for the Recommendation With the acquisition of Alliance Boots in Europe, Walgreens will be the first US pharmacy to operate retail stores on a global scale. Recently, Alliance Boots acquired Farmacias Benavides in Mexico, and Farmacias Ahumada in Chile. This means that the new holding company, Walgreens Boots Alliance will operate in Asia, North America, South America, Europe, and Asia. These two companies combined will create a synergy that will provide the US and Europe with tremendous value that enables innovative quality healthcare and treatment at an affordable price to millions of consumers across the world and establish themselves as a dominant global pharmacy. Walgreens chose to exercise its option to purchase the remaining 55% stake in Alliance boots on August of 2014 instead of February of 2015, which is almost a quarter before its original exercise date. The acquisition is expected to be finalized by February of 2015. These two companies have partnered with AmerisourceBergen in a ten year agreement. AmerisourceBergen has recently struck a deal with ProFarma in Brazil, allowing the company to develop relationships with drug makers across the world enabling it to receive better discounts and diversify products and sales. As AmerisourceBergen expands into foreign markets, it will be able to gain economies of scale. This also means that as it opens its relationships with larger amounts of drug makers, it will reduce the bargaining power of suppliers, and as a buyer will enhance its bargaining power. Walgreens and Alliance Boots have the right to acquire 23% equity of AmerisourceBergen in 2016 and 2017. The number of healthcare practitioners is forecasted to decrease in the next five years. This will enable Walgreens to perform treatments in a fast and convenient manner, enabling it to maintain a competitive advantage and remain a leader in the pharmacy industry. This will allow patients to no longer wait for treatments as they can conveniently receive them at Walgreens locations, or at the location of their choice through Walgreens health care practitioners. In Europe and the US, about 1 in 8 people, or 13%, are of age 65 and over. This number is expected to grow to 19% by the year 2030. According to statistics obtained by the NHTSA, 90 percent of people ages 65 and over use at least 1 prescription medication per week, with more than 40% of that group using more than five prescription medications per week, and 12 percent of that group using more than 10 prescription medications per week. This means that as the population ages, there will be more usage of medications. This is beneficial as it will allow the company to gain market share, due to the fact that the UK is one of the countries with the highest growth of the senior population. 32 million people are expected to be newly insured by 2019 thanks to the Affordable Care Act. Patient drug spending is expected to grow by 5.2%. Alternatively, without the Affordable Care Act, patient drug spending would be expected to grow by only 2.3%. This is an expected 2.9% more spent on drugs due to the Affordable Care Act alone. This shows that Americans are taking advantage of lower out-of-pocket spending allowed by their health insurance to purchase the medications that they need. pg. 1
There is a patent cliff that is expected to continue through 2015 and 2016. This will allow generic equivalents to take a large portion of the market share. According to Express Scripts, in 2013, 80% of total prescriptions filled were generics. Express Scripts is the pharmacy benefit manager for Walgreens, so this means that Walgreens prescription sales were 80% generic. This number is expected to grow to 87% by 2017 (IBIS World). Generic drugs present patients with lower costs related to prescription drugs, encouraging them to purchase the drugs they need to stay healthy and comply with regimens. 2. Company Analysis The company shows many strengths which include the range of services it provides, the range of products it provides, the partnerships that it holds, and social and political environmental changes that are taking place. Walgreens operates in different segments as a pharmacy to include the sale of prescription drugs, non -prescription drugs, general merchandising, foods, cosmetics, health products, along with other services. Prescription drugs accounted for 63% of sales in fiscal year 2013, whereas general merchandising accounted for 27% of sales and non -prescription drugs accounted for 10% of sales. Walgreens has recently been offering low cost generic prescription drugs that are cheaper and therefore more affordable to customers. On the down side however, this means that the cheaper the drugs, then the lower the profit margin for such products. However, this is expected to be offset by the higher number of sales of generic prescriptions. Walgreens provides services that allow customers to bypass the process of contacting a healthcare office, scheduling an appointment, and traveling to the practitioner s office to obtain the service. It does this by providing in-store treatments such as immunizations and vaccines for the flu, tuberculosis, tetanus, diphtheria, and pertussis. It also provides customers with intra venous treatments for pain, cancer, infections, heart conditions, and others. This provides ultimate convenience for customers as often times these treatments need to be done on short notice for employment, schooling, training, or travel. It is also extremely convenient as Walgreens has health care professionals that are able to administer these treatments in the comfort of a customer s home, in store, their workplace, or at a preferred physician s office. This is advantageous considering that there is a projected shortage of physicians over the next five years (IBIS World). Additionally, the company provides convenience by allowing the customer to refill prescriptions through the mail, the internet, in person in-store, in person drive-thru, and by the phone. Something else to take into consideration is the decision made by CVS to discontinue the sales of tobacco in their stores. This could be advantageous to Walgreens as they could attract customers that formerly shopped at CVS for these products. It is an opportunity for Walgreens to gain a larger percentage of the market share. In 2012 Walgreens entered a dispute with Express Scripts which cost the company about a 3% decline in prescription drugs sales of about 3%. The two companies have since settled this dispute, but pg. 2
Walgreens has not been able to regain all of the customers lost, and many of those customers switched over to CVS. Walgreens is dependent on the third-party pharmacy benefit manager Express Scripts to process and pay drug claims. However, shall another dispute occur, both Express Scripts and Walgreens will suffer a loss as Express Scripts is just as dependent, if not more dependent, on Walgreens as Walgreens is on Express Scripts. As Walgreens makes the move to operate globally, it will be exposed to foreign exchange risks. Considering that Alliance boots currently has retail stores or sells products in over 27 countries, it is fair to say that the new holding company will have to hedge its position in the foreign exchange market. Walgreens and Alliance Boots will remain subsidiaries of the new holding company, so exchange rates may be beneficial or may hinder the way in which it reports its financial statements. Walgreens has chosen to remain headquartered in the United States, which would not allow it to participate in tax inversion. This caused Walgreens to have a 4% drop in stock price in September of 2014, however this case proved to be an overreaction from investors as the price has bounced back since then. Critics claim that this decision will result in higher tax expenses as opposed to being headquartered in Switzerland, which would allow it to avoid certain corporate taxes. pg. 3
3. Industry Analysis The main industry in which Walgreens operates is in the Drug Stores and Pharmacies in the US industry NAICS 44611. This industry is divided in to different segments to include branded prescription drugs (31%), over the counter non- prescription medication (24%), specialty prescription drugs (12%), other merchandise and photo processing services (8%), personal health goods (7.5%), generic prescription drugs (7%), cosmetics and toiletries (6.5%), and food and beverages (4%) (IBIS World). There are three major players in this industry. Currently Walgreens holds 28.4% of the market share, CVS Caremark holds 50.6% of the market share, Rite Aid Corporation holds 10.4 % of the market share while the remaining 10.6% of the market share is held by other pharmacies with a total of 22,147 businesses (IBIS World). The industry is highly competitive as there are not many barriers to entry, however many smaller businesses are deterred to enter into the industry due to the high levels of competition from Walgreens and CVS. There is currently low globalization of the industry and the industry is in the mature stage of the business cycle. The industry has generated $256.6 billion in revenue and has generated $7.2 billion in profit. There has been an annual growth of 2.2% from 2009 2014 and has expected annual growth of 2.6% from 2014 2019 (IBIS World). The number of insured individuals is rising due to healthcare reforms. This means that consumers are able to afford prescription drugs due to lower out-of-pocket costs. The US has also seen a rising percapita disposable income (IBIS World), which means that people are able to be more compliant with refilling their medicines and taking the appropriate dosages. It is expected that there will be a 5.3% annualized rise in the number of prescriptions filled, which translates to 5.8 billion prescriptions filled over the next five years up to the year 2019. This in turn will stimulate the revenue generated from prescription drug sales for pharmacy companies. The projected shortage of physicians in the United States will allow for pharmacies to provide preventive and treatment care. There has also been a rise in the use of biologic drugs, which have a high margin, which is expected to raise profits from 2.8% to 3.1% from 2014 to 2019 (IBIS World). Biologic drugs call for the patient to adhere to strict regimens for them to work, which require refilling and repurchasing of the drugs. 8 of the 10 top pharmaceutical drugs will be biologic drugs by 2017 (IBIS World). pg. 4
Appendix: Inputs into valuation using multiples 2006A 2007A 2008A 2009A 2010A 2011A 2012A 2013A 2014 2015F 2016F Stock Price 45.07 36.43 33.88 26.88 35.21 35.76 48.07 60.52 77.648 78.2 Diluted EPS 2.03 2.17 2.02 2.12 2.94 2.42 2.56 2 4.22 4.25 Sales 53,762 59,034 63,335 62,420 72,184 71,633 72,217 76,392 117,534 120,942 Sales per share (diluted) 54.24 59.68 64.07 71.83 81.17 75.88 76.29 79.15 81.76 84.13 P/E 22.20 16.79 16.77 12.68 11.98 14.78 18.78 30.26 18.4 18.4 P/S 0.83 0.61 0.53 0.37 0.43 0.47 0.63 0.76 0.95 0.93 * Analyst's own calculations. Source of basic data: company's 10-K; Yahoo! Finance Sources: http://clients1.ibisworld.com/reports/us/industry/industryoutlook.aspx?entid=1054 http://finance.yahoo.com/ http://www.morningstar.com/ http://www.walgreens.com/?ext=googsl_brand_campaign_walgreens_exact_walgreens&sst=6e415f1 7-4f4a-8688-0b1b-000064b3dbd5 pg. 5