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Walgreen Company (WAG)Stock (Drug Stores Industry, Pharma & Healthcare Industry, Retail Industry)
 This article should cite more sources.  Walgreens (NYSE:WAG) generated $53.8 billion of revenue on which the company earned nearly $3.2 billion of operating profit in 2007. Fiscal 2007 marked the first year in which Walgreens' main competitor, CVS generated more sales than Walgreens ($73.6 billion of CVS revenue in 2007). In comparison to 2006, Walgreen saw a 13.4% increase in revenue and a slight growth in operating profit (from 5.8% to 5.9%) in fiscal 2007. The century old company has been consistently growing, adding over 500 stores during fiscal 2007; the retailer is still growing as it operated 6,727 stores as of the end of the third quarter of fiscal 2008 (May 2008)[1].Walgreens is poised to benefit from several key trends underlying strong growth fundamentals. The American baby boomer population is getting older, and retirees spend a disproportionate amount on prescription drugs. In addition, the increased demand for generic drugs have the dual benefit of being cheaper for consumers (i.e., higher demand) and generate higher gross margins in the short run for Walgreens and the rest of the pharmaceutical retail industry. However, gross margins on generic drugs fall in the long term as more manufacturers enter the market, which made a visible impact on Walgreens in the fourth quarter of fiscal 2007 as net profits slid due to falling profits on certain top-selling generic drugs. Through three quarters of FY08, the company has grown sales 10% to $44 billion[2]. The growth path is not all clear sailing for the drugstore giant, however. As with many industry sectors with strong growth prospects, pharmaceutical retail has attracted daunting competitors outside of the traditional drugstore retailers, most notably in the form of Wal-Mart. The behemoth omni-retailer announced that it would undercut pricing on generic drugs by as much as 50% compared to Walgreens, which may ignite a price war and put compounded pressure on the company's drug margins and front-store sales; Walgreens makes higher margins on beauty products, snacks, etc. and depends heavily on cross-category sales from those who come in to fill prescriptions. In addition, the U.S. government enacted Medicare legislation which reduced the reimbursement on prescription drugs supported by that program. Further cuts in Medicare spending would add to the margin squeeze for the company.
[edit] Business Operations Walgreens has been operating for over a century and in fiscal 2007 generated $53.7 billion in revenue. The company operates 6,297 pharmacies, in addition to 183 "convenient care clinics" through its Take Care Health Systems subsidiary, in the U.S. and Puerto Rico as of June 2008[3]. In fiscal 2007 Walgreens added over 500 stores to its operations and the company plans on opening over 550 new stores, an 8% increase), in fiscal 2008. However, Walgreens announced that it will slow its planned increases in 2009 and 2010 to 6% and 5% increases in stores, respectively.[4] The company has grown mostly through organic efforts of opening freestanding stores, which comprised 84% of all stores in 2005 compared to only 31% in 1995. Its recent acquisition of the 76-store Happy Harry's chain has been the only significant acquisition in the past 15 years. However, Walgreens may have to depend on further acquisitions if it wants to expand its retail presence as many desirable locations have become saturated with drugstores. [edit] Pharmacy RetailWalgreens is the largest U.S. chain drugstore by sales and profits, and the company Walgreens depends on its retail pharmacies to bring in a large percentage of the companies revenue. In fiscal 2007, Walgreens derived about 65% of its sales from prescription drugs and 10% of its sales from non-prescription drugs. [edit] Front Store OperationsThe company generated 25% of its revenue from its front store operations, which stocks general merchandise such as cosmetics, toiletries, household items, food, beverages and photofinishing. The typical Walgreens retail outlet devotes more square footage to its front-end compared to rivals such as CVS/Caremark and Rite Aid (RAD). With a higher mix of consumables than its competitors, Walgreen’s front store serves as a convenient alternative to supermarkets. Additionally, Walgreens' private brand sales now comprise approximately 17% of front-end merchandise. [edit] Happy Harrys AcquisitionWhile Walgreens has been committed to organic growth in retail operations, the company acquired the 76-store Happy Harrys in June 2006, marking its largest acquisition since 1986, when Walgreens bought out the 66-store Medi Mart chain. To put the acquisition in perspective, Walgreens operates over 5800 branded retail locations as of 2006.
  [edit] Trends and Forces[edit] Aging PopulationAn aging American segment, known as baby boomers, continues to fuel an increase in demand for prescription drug sales. The American Association of Retired Persons (AARP), reports that while people in the 25-54 age group fill between 5 and 12 prescriptions each year, people over the age of 55 fill between 19 and 24 prescriptions. As this generation of boomers gets older, chain drugstores will experience an increase in prescription sales for the next 10+ years. 
[edit] Medicare Part DThe introduction of Medicare Part D in January of 2006 has contributed to an increase in prescription drug utilization as the program provides coverage to an extra 5-8 million people who did not previously have creditable coverage. The program may have a negative impact on the drugstore retailer margins, however, as the transfer of dual eligible customers from Medicaid to Medicare will lower reimbursement rates. Walgreens has suffered a decline in pharmacy margins for senior prescriptions as millions of cash payors continue to enroll in Medicare Part D. However, the program could provide profitable gains to Walgreens and CVS/Caremark through their pharmacy benefit management (PBM) services. [edit] Generic Prescription DrugsThe retail drugstore industry will benefit from accelerated generic prescription drug sales, as a significant number of branded drugs will come off patent between 2006-2009. Walgreens expects to have at least 65% of their prescriptions filled with generic drugs by the end of 2007. While generic drugs have a lower price points, margins for these products tend to be higher for drug retailers, at least in the short term. In the long term however, as more manufacturers enter the market for each generic drug prices and profit margins fall for these medications. Furthermore, lower price points may lead to higher overall demand for certain prescription drugs which may or may not counteract falling profit margins. This could be a problem in the long term for Walgreens as exhibited in the fourth quarter of fiscal 2007, when net profits fell due to decreasing margins on generic drugs. For example, Walgreens sales of the generic drug Simvastatin nearly tripled in the fourth quarter of 2007 compared to the same quarter in 2006, however the gross profits from sales of the drug were basically unchanged between years. [edit] MedicaidOn January 1, 2007, the U.S. government issued Medicaid cuts under the Deficit Reduction Act (DRA) of 2005, calling for reduced reimbursement rates for prescriptions to pharmacies. Medicaid patients represent a small percentage of customers for Walgreens due to the shift to Medicare Part D for dual eligible beneficiaries. However, Medicaid contribution to the gross margins is important, and Medicaid cuts will lower pharmacy sales. Increased pressure on sales and margin may lead to industry consolidation, and as a result, Walgreens may be participant to acquisition transactions in the future. [edit] Threat of Mail-Order PharmaciesMail-order pharmacies pose a threat to physical drugstores, due to the lower consumer prices for prescription drugs. Mail-order pharmacies is the the fastest growing retail pharmacy business, and currently comprise about 19-20% of total U.S. prescription sales. Walgreens does have their own pharmacy benefit management (PBM) services, allowing the company to offer their large customer the option of migrating towards mail order pharmacy. [edit] Competition   Drugstore competitors to Walgreens, which realized $53.7 billion in 2007 revenue, include:
In addition to other drugstore retailers, Walgreens also competes for market share with supermarkets, convenience stores, mass merchants, Internet drugstores, and PBMs. Of late, supermarkets and mass merchants have lost considerable market share (currently at 12%) in the retail prescription business leaving a potential market share to be filled by Walgreens and its competitors. In particular, Wal-Mart (WMT) has grown its retail pharmacy business at its retail mega-stores. Wal-Mart is the third largest domestic retailer in terms of pharmacy sales, and it has continued to increase the number of total pharmacies in its installed store base. Wal-Mart’s also announced a strategy to undercut prices of generic drugs by 50% compared to traditional drugstores such as Walgreens. Such actions may catalyze pricing wars, which would put significant pressure on drugstore retailer margins.
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