Financial analysts highlighted Walgreen Co.'s improved front-end performance in reports on the drug store chain's fiscal 2011 first quarter results.


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Analysts: Walgreens sharpens front-end execution

December 23rd, 2010

NEW YORK – Financial analysts highlighted Walgreen Co.'s improved front-end performance in reports on the drug store chain's fiscal 2011 first quarter results.

"Walgreens appears to have established some positive momentum in its front-end business," William Blair & Co. analyst Mark Miller said in a research note on the drug chain's first quarter. "We believe vice president of merchandising Bryan Pugh has played a key role in upgrading the company's overall front-end assortment, pricing and markdown strategies, and direct sourcing capabilities, and we expect additional improvements will come over time."

For its first quarter, Walgreens reported a 6% rise in total sales to $17.34 billion and a 0.8% uptick in comparable-store sales, including a 0.4% gain in the front end. Earnings surged 19% to $580 million, or 62 cents per diluted share, easily exceeding the year-ago profit of $489 million, or 49 cents per diluted share, and the average analyst earnings-per-share estimate of 54 cents. Gross margins in the first quarter also rose 80 basis points year over year to 28.5%.

"The 80-basis-point improvement in the company's fiscal first-quarter FIFO gross margin was primarily the result of operational improvements in the front end," Miller explained in his report. "If we assume a 10-basis-point increase in Walgreens' pharmacy FIFO gross margin, then this would imply that front-end FIFO gross margins improved between 150 and 200 basis points on a year-over-year basis. The primary drivers of the margin improvement came from a combination of reduced promotion, fewer markdowns, better sourcing (i.e. initial benefits from direct sourcing initiatives in Asia) and higher prices/initial markup."

Deutsche Bank Securities analyst Bill Dreher also cited Walgreens' solid front-end execution — including lower expenses with its Customer-Centric Retailing (CCR) store optimization initiative — as driving the margin boost.

"Front-end gross margins were up significantly as a result of more effective pricing, promotions and sell-through, as well as a reduction in restructuring costs related to CCR inventory-related write-downs," Dreher wrote in a research note on Walgreens' first quarter.

CCR, he added, is also putting Walgreens in a better position amid a still cloudy consumer spending climate.

"With unemployment at 9.8%, the macro environment remains challenging and consumers
continue to focus on value. Nonetheless, Walgreens' CCR initiative and the addition of beer and wine to nearly 5,000 stores today, versus a little under 2,000 in November 2009, is helping drive front-end sales," Dreher stated. "We believe the impact of CCR, which is now in approximately 2,200 stores, or about 30% of the chain (management expects the CCR format to be in 5,500 by the end of 2011), beer and wine, growth in higher-margin generics and improving comps should help lift gross margins for the remainder of the year."  

Walgreens' strategy to scale back new drug store openings also stands to aid profits going forward, according to Miller. The retailer said that in the first quarter it had a net gain of 89 stores after relocations and closings, compared with a net gain of 150 in the fiscal 2010 quarter. Plans call for organic store growth of 2.5% to 3% in 2011.

"Walgreens' bottom-line results are only just beginning to benefit from the reduction in new store growth — new Walgreens stores typically lose money during their first three years of operation," Miller wrote.

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