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Muge Tian Yanlei Xu Ben Hier Mohamed Ibrahim November 29, 2007

Muge Tian Yanlei Xu Ben Hier Mohamed Ibrahim November 29, 2007. Agenda. Company Overview Macroeconomic Outlook Industry Competitors Recent Developments Portfolio Position DCF Valuation Comparable Multiple Valuation Recommendation. Company Overview.

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Muge Tian Yanlei Xu Ben Hier Mohamed Ibrahim November 29, 2007

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  1. Muge Tian Yanlei Xu Ben Hier Mohamed Ibrahim November 29, 2007

  2. Agenda • Company Overview • Macroeconomic Outlook • Industry Competitors • Recent Developments • Portfolio Position • DCF Valuation • Comparable Multiple Valuation • Recommendation

  3. Company Overview • Incorporated as an Illinois corporation in 1909, as a successor to a business founded in 1901 • Nation’s largest retail drugstore chain (based on sales) • 33rd year of consecutive sales and earnings growth • Sales are expected to continue to grow • Aging population • Introduction of lower priced generics • Development of innovative drugs • Convenience positioning: 139.1 million people live within 2 miles • Traffic: 5 million shoppers in one store location daily • As of Aug 31,2007, 5997 stores located in 48 states and Puerto Rico.

  4. Walgreens’ Business Prescription Drugs Candy Non-Prescription Drugs Photofinishing Walgreens Greeting Cards Beauty Care Personal Care Seasonal Items Household Items Convenience Foods

  5. Product Class

  6. Top Five States 2010~2011 Florida Texas Illinois California Arizona 736 587 528 476 234 US Demography: Over 50% of baby boomers in Florida, Texas, Illinois, California, New York, Pennsylvania, Ohio, Michigan, & New Jersey

  7. Growth Strategy • Store openings • Locating new stores, relocating/closing exiting stores, site selection (convenience positioning) • 2007, opened or acquired 563 stores. • Continue growth, anticipating more than 7000 locations in 2010.

  8. Acquisitions • In 2006 : • Merger with Happy Harry’s pharmacy chain • Purchase of : • Medmark Inc. ( Specialty pharmacy ) • Schraft’s ( Specialty pharmacy) • Canadian Valley medical ( Home care services) • Home pharmacy of California (home infusion service) • Controlling interest in Senior Med • In 2007 : • Option Care Inc. (specialty pharmacy & home infusion service) • Take care health systems (convenient care clinic operator) • Remaining interests in Senior Med.

  9. Walgreens Risk Factors Competition Regulations Product Liability Economic Condition Reduction Reimbursement Store Location PharmacyPersonnel

  10. Oil Price Consumer Confidence Macroeconomic Conditions Source: Wall Street Journal The Conference Board, The Consumer Confidence Press Release

  11. Industry Overview • Industry: Drug retail • CVS/Caremark Corp. (CVS) and Rite Aid Corp. (RAD) • Business segments: prescription and non-prescription drugs, and general merchandise

  12. Industry • Sources and availability of raw materials • numerous domestic and foreign suppliers • Seasonal variation • timing and severity of cold/flu season, holidays • Dependence upon limited number of customers • no customers counts for 10% or more of consolidated sales • Competition • chain and independent drug stores, mail order prescription providers, grocery stores, convenient stores, mass merchants, and dollar stores • service, convenience, variety and price

  13. 5-Year Industry

  14. 1-Year Stock Performance

  15. Porters Five Forces: Retail Drug Industry • Rivalry: High • Existing drug stores • Direct mail pharmacy benefit managers • Grocery stores & big box retailers • Threat of Substitutes: Low • Few alternative choices for products sold at Walgreens/Drug Retailers • Bargaining Power of Buyers: Moderate • Insurance companies • Walgreens receives premium prices for front end convenience items • Bargaining Power of Suppliers: High • Drug companies have price control • Barriers to Entry: Moderate • High initial capital expenditures & supplier relationship required

  16. Generic Pipeline • Lipitor (#1) and Prevacid (#3) are among the top selling drugs in the U.S. • Generic drug pipeline will not be as robust as 2006 ($14B) & 2007 ($14B) • Opportunity for higher margin generics despite declining reimbursement rates Source: Forbes.com

  17. Path From Branded to Generic • Stage III • 6/2/2007 - Future • Generic Exclusivity Ends • Sold at 52% of Branded Price • Insurance Companies Reduce Reimbursement • Stage II • 1/2/2007 - 6/2/2007 • First Generic Version Available • 6 Month Exclusivity • Sold at 94% of “Branded” Price • Insurance Companies Offer High Reimbursement Rates • Stage I • 1/1/1995 - 1/1/2007 (Est. 12 Yrs) • Full Price “Branded” Drug Available • Low Margin Product

  18. Recent Developments • Wal-Mart Threat • In June 07, Wal-Mart announced a $4 prescription program • The effect didn’t last for long time (less than 6 weeks). • This is not a threat because: • The drugs covered by this program are not widely demanded by patients. • For Walgreens prescription drug represents 65% of sales , of which 94.8% Third party sales. • Third party : • 1-Medicare : senior above 65 years • 2-Medicaid : low income people • 3-Private insurance • Wal-Mart targets those who are not covered by any insurance and that represents 5% of the USA population.

  19. Recent Developments Cont. • On Oct 1st 2007 , Walgreen announced a decline in Q4 earnings by 3.8%. • Although the annual data showed an increase in earnings by 16.6%, sales increased by 13.3%. • Walgreen lost 15% ($7.04) on that day. • Walgreen is held by many institutional investors, so when Walgreen missed their expectations, shares sold off abruptly

  20. Recent Developments Cont. • The management attributed this decline : • Lower generic drug reimbursement • Higher SGA, higher salary, store expenses, higher advertising cost and some administrative costs related to acquisitions • The absence of new blockbuster generic drugs to enter the market during Q4. • The expansion in third party selling (Medicare program) that has lower margins.

  21. The Zocor Story • Cholesterol drug • Huge seller in 2005 more than $ 4 billion • Generic became available June 2006 • Sales increased as insurers force people to switch to the generic, even from other drugs like the Lipitor and Crestor. • More generics start to appear, insurers force drug makers to lower the price, insurers pay lower reimbursements. • Even when sales of Simvastatin (generic Zocor) tripled, yet gross profit was flat. • At same time SGA costs increased by 15%, extra was needed staff to fill the increase in the size of business

  22. Patent Expiration Schedule

  23. RCMP Position Purchased 1000 shares of WAG on October 6th, 1999 for $25.00/share On September 20th, 2006, sold 500 shares @ $49.94/share for a realized gain of $12,470 Currently own 500 shares of WAG, trading at $38.31 as of Nov 28, 2007 for an unrealized gain of $6,655 or 53.24%.

  24. Role in Portfolio

  25. Correlation Matrix

  26. Lease Obligations • 19.1% of stores are owned while 80.9% are leased • The present value of lease obligations “quasi debt” is $15.794 billion • We should take the risk from these operating leases into consideration

  27. DCF Assumptions • Store openings and Capex • Increase trend SGA • Increase gross profit margin • Sales will grow in 08 due to patent expiration • Wacc Calculation : • Equity 93% Debt 7% • Beta 0.55 • Rf 4.05% (10 yr treasury note) • Ke 7.35% • Kd 5.36% • WACC 7.07% • Long term growth rate 3% • DCF Value: $ 41.66

  28. Comparable Analysis Source: Onesource

  29. Public Comparables Analysis Closing Price: $38.31 P/E (TTM): 22.94 * $2.03 = $46.57 Forward P/E: 16.83 * $2.03 = $34.16 Average: $40.37 Source: Onesource & Google Finance

  30. Recommendation • Hold 500 Shares • DCF valuation near current stock price • Generic drug outlook not as robust as 2006-07 • Low correlation to existing portfolio holdings • Macroeconomic outlook

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