Walgreens third quarter results were disappointing as the company reportedly driven by a lower than expected gross margin.
The SG&A growth was a bigger worry entering the third quarter and was surprisingly ahead of the estimate has grown to a more steady state rate says their management. Despite a more stable front end margin, along with an in line Alliance Boots synergies, the management of the company pointed to slower growth of generics and the reimbursement pressure added to the negative growth factors.
The decline in gross margin, Walgreens had previously indicated after the generic peak would be less than the previous cycles. This information however is not as reassuring.
To add to that, the EPS was lower accredited from Alliance Boots supposedly to to IFRS to GAAP and accounting adjustments appear to not help earnings visibility. In order for meaningful shares gains from here on we acknowledge that stronger sales and positive data points on margins may be required. There is significant opportunity with the strategic partnerships and script utilization as things should be rock solid with healthcare reform.
Walgreens reported adjusted EPS of $0.85 which is up 18% year over year and was $0.03 lower than the estimate forward primarily by a lower than expected gross margin. The gross margin of 29.2% was up 60 basis points from last year however came in 30 basis points short of the estimate as well as the rate of increase slower from the second quarter ( a 120 basis point increase). Of importance is the front end margins and synergies from the Alliance Boots investment as they were efficiently in line. Analysis of the gros margin trend relative to the generic penetration, it is noted that the gross margin simmered off enough to gain attention. In addition, the adjusted SG&A growth of 4.5% without including the legal settlement and acquisition costs, was ahead of the estimated 4.9% and in comparison is better with the 5.3% gross profit growth.
In regard to Alliance Boots, despite the synergies going on plan, the accretion from the investment was $0.02 lower than Walgreen’s management guidance on higher than expected IFRS to GAAP accounting adjustments.
At present, shares trade at 11.7 times the 2014 calender EPS estimate of $3.85 which is believed to be an enticing valuation in comparison to significant earnings growth with Alliance Boots acquisition and AmerisourceBergen (ABC $53.55) partnership. Whatever, the stronger execution will be paramount to valuation improvement.
