Taking the long view provides consistent, steady sales results

Drug Store News, March 22, 2004 by Michael Johnsen

In the past six years, Walgreens grew its store base by almost 66 percent. As a result, Walgreens' top-line has more than doubled, to $32.5 billion from $15.3 billion. Walgreens plans to grow its store base by another 66 percent by 2010, and the drug retailer could very well double sales again, breaking the $60 billion barrier.

In the past year, Walgreens' sales climbed 13.3 percent. And the chain's profit growth has kept pace, approaching $1.2 billion in the fiscal year ended Aug. 31 for a gain of 15.4 percent. And Walgreens is tracking pretty close to that pace thus far this fiscal year. The chain is projected to hit $683.1 million for the first half of 2004, which ended February, a percent increase over last year of 13.4 percent.

"We're off to a very solid start on what we anticipate will be our 30th consecutive year of record sales and earnings," David Bernauer, Walgreens chairman and chief executive officer, told a packed crowd at the company's annual meeting in January. "Celebrate for a nanosecond, then move on."

And in one sentence, Bernauer summed up how Walgreens is able to accomplish its sustained growth over decades. Great. Good job. What's next?

The answer to that question is crucial to Walgreens' quest to maintain its sales and earnings streak well past the three-decade mark. The company is in the right business at the right time, right in line with a projected increased demand in prescription services among a burgeoning senior population. And with $1 billion in the bank and another $3 billion in real estate holdings, it's also in the right financial place to capitalize on its position. And it's doing that by pouring more than $1 billion this year into the construction of some 450 stores, new distribution capacity and new technology.

A focus of Walgreens' capital development program this year will be supply chain management. The company will open one state-of-the-art distribution center in Southern California this spring and is breaking ground on another in South Carolina in the summer for a possible 2007 opening.

Even with all of its capital expenditure commitments, the company still predicts it will maintain sales and earnings momentum and positive cash flow this year. And that, said Bernauer, is the only answer Walgreens can give to investors dismayed over a stock price that largely has stalled since its run-up in the 1990s and early 2000.

"The only thing we can do to raise our stock price is to continue to post solid earnings increases," Bernauer noted in the company's 2003 annual report.

Walgreens stock closed at $31.04 on Sept. 29, the day it announced fiscal 2003 results. That was up only 51 cents from the year previous, a 1.2 percent increase. "We believe [Walgreen's stock] will bounce up when Wall Street sees we can continue our store growth and profit momentum," Bernauer added. And Wall Street may be turning the corner on becoming a believer. The stock was trading at about $35 at the beginning of this month, an increase of approximately 12 percent.

"Because they take the long-term view, because they look at the health of the business over many years and don't run the business [in an effort to realize] short-term results ... the end result is a consistent [sales] record," said Goldman Sachs analyst John Heinbockel. If Walgreens had scaled back its aggressive new-store campaign of late, near-term results would have shown greater gains, but at the cost of the chain's future growth potential. Basically, Walgreens' sales growth engine would have sputtered, Heinbockel said, without profit contributions steadily flowing to the bottom line from a steady stream of maturing stores opened in recent years.

Walgreens is laying the groundwork for future growth through its commitment to building free-standing stores, many of them 24-hour operations, on prime real estate. Indeed, as the chain continues to stake its leadership position with more labor-intensive 24-hour locations and drive-through pharmacies than the competition, it eventually will reap the benefits of convenience.

"The next five to 10 years is going to see more market-share shifts than we've seen up to this point in pharmacy," Heinbockel said. For example, there are cross-currents within the business of pharmacy that could negatively impact sales, such as Medicaid prescription drug pricing or generic conversion rates, to name two.

"The [pharmacy] market's still going to grow at a decent rate relative to the rest of consumer spending, but it may not grow as fast." That makes grabbing market share that much more important, Heinbockel said.

And Walgreens is possibly better positioned against those ensuing market-share battles than its competitors. Walgreens, for instance, boasts the lowest cost--at $4.90 per prescription--to fill a script than any retailer today, Heinbockel argued, citing Goldman Sachs research.

"There's a direct correlation. There's a lot of fixed costs in pharmacy--labor [for example]," Heinbockel said, and Walgreens is able to leverage those costs through a higher pharmacy throughput. "You get your throughput up by being more convenient [and] taking care of the customers."