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Walgreens Boots Tops Q2 Earnings, Rite Aid Deal in Focus

Walgreens Boots Alliance, Inc.WBA reported adjusted earnings per share (EPS) of $1.31 in the second quarter of fiscal 2016, up 11% from the year-ago adjusted number. Adjusted EPS also beat the Zacks Consensus Estimate by 3.1%.

Per management, overall earnings growth was primarily driven by the cost-cutting initiatives as well as additional efficient work practices recently adopted by management.

On a reported basis, net earnings came in at $0.9 billion or 85 cents per share, a significant decline of 54.5% or 56% respectively, from the year-ago quarter.

Total Sales

Walgreens Boots recorded total sales of $30.2 billion in the fiscal second quarter, up 13.6% year over year primarily due to the full consideration of Alliance Boots for the entire quarter. However, the top line missed the Zacks Consensus Estimate of $30.7 billion. Moreover, unfavorable foreign currency fluctuation affected the quarter’s sales growth by approximately 2.4%.

Segments in Detail

Walgreens Boots currently reports under three operating segments: Retail Pharmacy USA, Retail Pharmacy International and Pharmaceutical Wholesale.

The Retail Pharmacy USA division delivered sales of $21.5 billion in the reported quarter, reflecting an increase of 2.1% on a year-over-year basis. Within this segment, total sales in comparable drugstores increased 2.2% while comparable retail stores dropped 0.3%. The decline was due to soft cough, cold and flu product sales, which had an estimated negative impact of approximately 100 basis points on comparable retail sales.

Pharmacy sales, which accounted for 65% of the division’s sales in the quarter, increased 3.2% from the year-ago quarter, while pharmacy sales in comparable stores climbed 3.7%.

The Retail Pharmacy International division delivered sales of $3.7 billion. On a constant exchange rate (CER) basis, comparable store sales in the second quarter increased 2.3% year over year, driven by growth in the U.K. and particularly strong growth in the Republic of Ireland.

The Pharmaceutical Wholesale division recorded quarterly sales of $5.6 billion, up 1.6% year over year, at CER and excluding acquisitions and dispositions.

Margins

Gross profit increased 15.4% year over year to $7.94 billion and adjusted gross profit improved 13.8% to $8 billion. Consequently, reported gross margin improved 40 bps, while adjusted gross margin was flat at 26.5% in the fiscal second quarter.

Adjusted selling, general and administrative (SG&A) expenses increased 10.8% to $5.9 billion. Nevertheless, adjusted operating income increased 22.9% to $2.1 billion owing to higher gross profit. Consequently, adjusted operating margin expanded 50 bps to 7%.

Financial Condition

Walgreens Boots exited the reported quarter with cash and cash equivalents of $3.6 billion, up from $2.6 billion in the first quarter of fiscal 2016. Long-term debt was $13 billion, compared with $13.2 billion in the prior quarter.

Moreover, the company generated operating cash flow of $3.1 billion in the reported quarter compared with $2.3 billion a year ago. The resultant free cash flow was $2.1 billion.

Guidance

Walgreens Boots has raised the lower end of its EPS guidance for fiscal 2016. The company currently expects adjusted EPS in the $4.35–$4.55 range for the full fiscal, as against the earlier guided $4.30–$4.55. The Zacks Consensus Estimate for fiscal 2016 earnings is $4.48, within the company’s guidance range.

This guidance assumes no material accretion from the proposed acquisition of Rite Aid, equity income from AmerisourceBergen on a two-month reporting lag; and no significant changes in currency exchange rate.

Progress on Rite Aid Acquisition

In Oct 2015, Walgreens Boots announced that it has agreed to acquire U.S.-based retail pharmacy chain – Rite Aid Corporation (RAD), for a total enterprise value of $17.2 billion, including acquired net debt. The transaction is expected to close in the second half of calendar year 2016. Currently, this acquisition is progressing as per Walgreen Boots’ plans, following Rite Aid’s shareholders approving the transaction on Feb 4, 2016. However, the transaction is still subject to the expiration or termination of applicable waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and other customary closing conditions.

Walgreens Boots expects this transaction to be accretive to its adjusted EPS in its first full year after completion. Additionally, the company expects to realize synergies in excess of $1 billion.

Our Take

Walgreens Boots reported a mixed second-quarter fiscal 2016 with earnings comfortably beating the Zacks Consensus Estimate, while the top line closely missed the mark. We note that the reported results echo the trend exhibited by the company in the preceding three quarters as well. On a brighter note, the company holds a strong cash balance as is evident from its increased cash flow reserve in the reported quarter, while its proposed on-track buyout of Rite Aid is expected to expand its business realm in the U.S. over the long term.

However, foreign exchange fluctuation continued to adversely affect the company’s result in the reported quarter and no respite is expected in this regard any time soon.

Nevertheless, the synergies from the Walgreen Co. and Alliance Boots merger continue to boost our confidence in the stock. Combined net synergies as of second quarter fiscal 2016 were $617 million and the company is well on track to reach at least $1 billion in synergies in fiscal 2016.

 Zacks Rank

Walgreens Boots currently has a Zacks Rank #2 (Buy). Some other well-ranked stocks in the medical sector are LeMaitre Vascular, Inc. LMAT, Orthofix International N.V. OFIX and Baxter International Inc. BAX. While LeMaitre Vascular and Orthofix sport a Zacks Rank #1 (Strong Buy), Baxter holds a Zacks Rank #2.

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