Transcript Number of shares
Date: November 21, 2013 Jun Yuan (Jason) Chan Hisham Haider Dewan Zige (Z) He Charalampos (Haris) Ntantanis 1
Agenda
Holding Information Company overview Macro-economic overview Industry analysis Equity market performance Financial analysis and projections Valuation Recommendation
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Current Holdings
Number of shares: 500 purchased Oct 05, 1999 at $25/share Total Purchase Price = $12,500 Current Market Value ($59.40 per share*) = $29,700 Holding period return = 137.60% Annually compounded return = 6.377% Allocation of portfolio = 14.75% Source: Yahoo Finance; *$59.40 per share as of Nov 20, 2013
Introduction to Walgreen (NYSE:WAG)
Walgreen Co. operates the largest drugstore chain in the U.S. with net sales of $72.2 bn. in FY 2013 Provides customers access to pharmacy, consumer goods and services, and health and wellness services Service through drugstores, mail, phone and online August 2, 2012, WAG held a 45% investment interest in Alliance Boots GmbH, Europe based pharmacy-led health and beauty group Source: Walgreen Co. 2013 10K filing Item 1. Business
Business Segments
Prescription and non-prescription drugs General merchandise
• Household items, convenience and fresh foods, personal care, beauty care, photofinishing, and candy Source: Walgreen Co. 2013 10K filing Item 1. Business
Revenue Breakdown by Segment
2013 2012
27% 10% 63% Prescription Drugs General Merchandise Non-prescription Drugs 25% 12% 63% Prescription Drugs General Merchandise Non-prescription Drugs
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Source: Bloomberg terminal Walgreen Co. revenue breakdown by segment
Distribution Network
6.2 million daily visits to stores in 2013 Location Type Drugstores
Worksite Health and Wellness Centers Infusion and Respiratory Services Facilities Specialty Pharmacies Mail Service Facilities
Total 2011 7761
355 83 9 2
8210 2012 7930
366 76 11 2
8385
Source: Walgreen Co. 2013 10K filing Item 1. Business
2013 8116
371 82 11 2
8582 7
Distribution Network
Mobile Alliance Boots expands into Europe New store through M&A Online eCommerece Mail order
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Annual Revenue
Revenue
$75 000 $70 000 $65 000 $60 000 $55 000 $50 000 $53 762 $59 034 $63 335 $67 420 $45 000 $40 000 2007A 2008A 2009A Source: Walgreen Co. 10K filing from 2007 to 2013 Statement of Earnings 2010A $72 184 2011A $71 633 2012A $72 217 2013A
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3 000,00 2 500,00 2 000,00 1 500,00 1 000,00 2 006,00
Annual Net Income
2 091,00 2 714,00 500,00 0,00 2009A 2010A Source: Walgreen Co. 10K filing from 2007 to 2013 Statement of Earnings 2011A 2 127,00 2012A 2 450,00 2013A
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Same Store Sales Growth
Source: Susquehanna Financial Group, LLLP (SFG) Research Walgreen Company Update October 3, 2013, page 3
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Mergers, Acquisition and Partnerships
AmerisourceBergen: 10 year pharmaceutical distribution agreement to source branded and generic drugs Acquisition of USA Drug, Super D Drug, May's Drug, Med-X, Drug Warehouse Acquisition of Kerr Drug (76 retail drugstores in South Carolina)
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Source: Walgreen Co. 2013 10K filing Item 1. Business - Business Development
Equity Stake of Alliance Boots
WAG has 45% investment in Alliance Boots at $6,690.23 Mil giving WAG access to EU markets
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About Alliance Boots
Source: Alliance Boots Annual Report 2012-13 page 1-2
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Option to Buy Alliance Boots
WAG has a call option to acquire remaining 55% equity interest during the 6 month period beginning February 2, 2015 Will be purchased with cash of £3.133 billion ($5.0 Bil. as of August 31, 2012) and stocks of WAG 1 Additional 55% stake in AB estimated to cost $8.177 Bil.
2 Alliance Boots had approximately $10.1 billion of outstanding debt, including short-term borrowing 2 Net realized synergy of $154m was greater than expected range of $130m to $150m was greater than expected in 2013 4 as of March 31, 2013 (Approximately £6.7 billion); 4. http://investor.walgreens.com/releasedetail.cfm?ReleaseID=793976
Dispute Resolution with Express Scripts
WAG derives significant portion of sales from prescription drug sales reimbursed through prescription drug plans by pharmacy benefit management (PBM) companies Lost network of Express Scripts, Inc. for more than eight months in 2012, which led most patients in plans transition to a new pharmacy Even after resuming PBM relationship all customers may not come back
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Source: Walgreen Co. 2013 10K filing Item 1A. Risk Factors
Source: Google Finance
Equity Performance
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Technical Analysis
Source:
http://finance.yahoo.com/q/ta?s=WAG&t=1y&l=on&z=l&q=l&p=m50%2Cm200&a=&c=
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Macro-economic Overview
Increasing number of physician visits Rising cost of pharmaceutical products in U.S.
Total healthcare expenditure $5 trillion globally Aging population in U.S., U.K., and E.U.
Recessionary or low growth environment in EU: UK GDP grew 0.8% between July and September Source: 1. IBISWorld Industry Report 33451b Medical Device Manufacturing in the US October 2013, page 4. 2. Source: OECD. Health Data 2013. Frequently Requested Data. http://www.oecd.org/els/health-systems/oecdhealthdata2013-
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frequentlyrequesteddata.htm
3. http://www.bbc.co.uk/news/business-24668687
Macro-economic Outlook
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Drug Retail Industry
Source: IBISWorld Industry Report 44611 Pharmacies & Drug Stores in the US, Page 4
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Industry Growth Drivers
1.
2.
3.
4.
Disposable income rising Aging population (13.7% of the U.S. population is over 65) Number of people covered by private health insurance (49.1 Mil. or 16% of the U.S. population uninsured) Number of physician visits expected to increase
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Patient Protection & Affordable Care Act: Impact on WAG
Removed employees from company healthcare plan Subsidize roughly 160,000 employees to purchase insurance Aside from rising health-care costs, the company cited compliance related expenses
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Source: http://online.wsj.com/news/articles/SB10001424127887323527004579081563998551366
Risks
Increased competition from other large chain retail pharmacies Reimbursement levels under government budget pressures, health-care reform, and PBM consolidation The loss of large PBM customer and failure in recapturing scripts that were lost due to the Express Scripts dispute Performance from Alliance Boots comes in below expectation and prior synergy targets are not realized Exposure to Europe's troubled economies Increased financial leverage
Porter’s Five Forces for Walgreen
Threat of new entrant:
High
Bargaining power of buyer:
High
Competitive Rivalry:
High
Threat of substitute product:
Medium
Bargaining power of supplier:
Medium 25
Management Outlook and Performance
Bad handling of PBM Express Scripts (ESRX) shows weakness in handling difficult negotiation Management optimistic about Alliance Boots acquisition Expects to acquire smaller local chains in U.S. Plans to open more in-store clinics Source: Walgreen Company WAG Q4 2013 Earnings Call Transcript http://www.morningstar.com/earnings/earnings-call-transcript.aspx?t=WAG
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Company Life Cycle
Source: http://businessplanning.org/files/industry-lifecycle.png
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Strengths
Walgreen SWOT Analysis
• Strong brand awareness • Distribution network • Diversified retail channels
Weaknesses
• High operating leverage (lease) • Exposure to weak EU economy
Opportunities Threats
• Strategic acquisitions and expansions • Growth of online retailing • Rising healthcare expenditure • Latent demand for beauty products • Global economic slowdown • Stringent government regulations • Highly competitive industry • Lack of synergy after acquisitions
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Financial Analysis
Ratio Analysis, DuPont Analysis, Lease
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Liquidity Ratios Current Ratio Quick Ratio Cash Ratio 2009A
1.78
0.78
0.17
Solvency Ratios Debt/Assets Debt/Equity Interest Coverage 2009A
0.09
0.16
39.12
Activity Ratios A/R Turnover Fixed Asset Turnover Total Asset Turnover 2009A
25.37 5.86
2.52
Ratio Analysis
2010A
1.60
0.61
0.16
2011A
1.52
0.53
0.13
2010A
0.09
0.17
40.68
2010A
27.52 6.03
2.57
2011A
0.09
0.16
61.48
2011A
28.91 6.26
2.63
2012A
1.23
0.43
0.12
2012A
0.16
0.30
39.36
2012A
33.06 5.95
2.14
2013A
1.34
0.57
0.18
2013A
0.14
0.26
23.88
2013A
27.44 5.95
2.04
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Profitability Ratios Operating Profit Margin Net Margin ROA ROE (Book Value) Greenblatt Ratios EBIT/Tangible Assets EBIT/EV 2009A
5.13% 3.17% 7.98% 13.95%
2009A
14.32% 0.075
Ratio Analysis
2010A
5.13% 3.10% 7.96% 14.52%
2010A
15.11% 0.088
2011A
6.05% 3.76% 9.89% 18.28%
2011A
16.64% 0.074
2012A 2013A
4.84% 2.97% 6.36% 11.66%
2012A
15.37% 0.103
5.46% 3.39% 6.91% 12.59%
2013A
15.07% 0.059
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DuPont
DuPont Analysis Tax Burden Interest Burden Operating Profit Margin Asset Turnover Leverage ROE 2009A
0.6340
0.9744
5.127% 2.5191
1.7489
13.95%
2010A
0.6199
0.9754
5.129% 2.5659
1.8247
14.52%
2011A
0.6320
0.9837
6.047% 2.6293
1.8491
18.28%
2012A
0.6300
0.9746
4.836% 2.1407
1.8349
11.66%
2013A
0.6290
0.9886
5.456% 2.0354
1.8238
12.59%
Dupont Analysis
3,0000 2,5000 2,0000 1,5000 1,0000 0,5000 0,0000 Tax Burden Interest Burden Operating Profit Margin Asset Turnover Leverage ROE
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2009A 2010A 2011A 2012A 2013A
Walgreens Leases
• • Walgreens owns approximately 20% of its operating locations; the remaining locations are leased premises. Initial terms are typically 20 to 25 years.
2014 2015 2016 2017 2018 Later
Total minimum lease payment Capital Leases (in $mil)
19 19 18 17 15 270
$358 Operating Leases (in $mil)
$2,536 2,514 2,464 2,389 2,292 23,507
$35,702
Valuation
DCF, Relative valuation, Benjamin Graham formula
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Cost of capital
Weighted average cost of debt Cost of equity using CAPM ROE (5 year average ROE) Cost of equity using goal post method Market value of debt Market value of equity Weight of debt Weight of equity Tax rate
Calculated WACC
Business Risk Premium
Adjusted WACC 1 (Calculated WACC + Business Risk Premium)
2.76% Weights 8.04% 70.00% 14.10% 30.00% 9.86% 5,086.30
57,354.30
8.15% 91.85% 35.00%
9.20%
1.00%
10.20%
Beta (From 1/3/2012 to 11/11/2013) Market risk premium (Rm-Rf) 10 year treasury yield Cost of equity using CAPM 0.8972
6.00% 2.66% 8.0429%
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Free Cash Flow to Firm (Option Not Exercised)
EBIT Less: Income Taxes Plus: D&A Less: CapEx Less: Change in Working Capital FCFF to WAG FCFF to AB FCF used in DCF 2014P
4,322.79 1,512.97 1,169.60 1,383.20 738.52
1,857.70
$593.84
2,451.54 2015P 2016P
4,538.92 4,765.87 1,588.62 1,668.05 1,169.60 1,169.60 1,383.20 1,383.20 279.38 293.34
2,457.33 2,590.87
$611.66 $630.01
3,068.99 3,220.88 2017P
5,004.16 1,751.46 1,169.60 1,383.20 308.01
2,731.10
$648.91
3,380.01 2018P
5,254.37 1,839.03 1,169.60 1,383.20 323.41
2,878.33
$668.38
3,546.71 36
Free Cash Flow to Firm (Option Exercised)
EBIT Less: Income Taxes Plus: D&A Less: CapEx Less: Change in Working Capital FCFF to WAG FCFF to AB FCF used in DCF 2014P
4,322.79 1,512.97 1,169.60 1,383.20
2015P 2016P
4,538.92 4,765.87 1,588.62 1,668.05 1,169.60 1,169.60 1,383.20 1,383.20
2017P
5,004.16 1,751.46 1,169.60 1,383.20
2018P
5,254.37 1,839.03 1,169.60 1,383.20 738.52
1,857.70
279.38 293.34
2,457.33 2,590.87
308.01
2,731.10
323.41
2,878.33
$593.84 $1,359.24 $1,400.02 $1,442.02 $1,485.28
2,451.54 3,816.57 3,990.90 4,173.12 4,363.62 37
DCF Valuation
Option Not Exercised Option Exercised WACC Terminal Value (at 2018) Terminal Growth Rate Implied Enterprise Value Plus: Cash Less: Debt Value of equity Shares Outstanding Estimated price per share
10.203% $59,463.60 4.00% $ 48,215.01 $5,086.30
$43,128.71 955.20
$45.15
WACC Terminal Value (at 2018) Terminal Growth Rate Implied Enterprise Value Plus: Cash Less: Debt Value of equity Shares Outstanding Estimated price per share
10.203% $73,159.71 4.00% $58,872.35 $5,086.30
$53,786.05 955.20
$56.31
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Company Name
Comparable Companies
Market Capitalization Revenue AmerisourceBergen Corporation (NYSE:ABC) Cardinal Health, Inc. (NYSE:CAH) CVS Caremark Corporation (NYSE:CVS) Express Scripts Holding Company (NasdaqGS:ESRX) Omnicare Inc. (NYSE:OCR) Rite Aid Corporation (NYSE:RAD) Safeway Inc. (NYSE:SWY) Walgreen Co. (NYSE:WAG)
15,821.2 114,215.89 21,830.6 84,901.05 77,513.5 130,339.21 53,126.4 102,289.36 5,944.0 4,819.1 8,369.0 57,354.3 6,519.66 25,438.02 38,407.02 75,437.34
Subjective weight
10.00% 5.00% 40.00% 5.00% 5.00% 25.00% 10.00%
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Relative Valuation
TEV/Total Revenues TEV/EBIT TEV/EBITDA TEV/Forward Total Revenue (Capital IQ) TEV/Forward EBITDA (Capital IQ) P/Diluted EPS Before Extra Forward P/E (Capital IQ) Price/Sales
Multiple value*
0.5x
12.2x
9.2x
0.5x
8.8x
24.1x
16.9x
0.4x
Implied price per share
$37.33
$46.88
$43.17
$38.79
$47.95
$60.44
$61.16
$30.92
Implied Price per Share Weighted average (using subjective weights for companies) $45.83
40 *Using subjective weights for companies
Benjamin Graham's Formula
Ben Graham Formula (Option not exercised) Current (normal earnings) Expected annual growth rate (%) Number of shares Estimated price per share Ben Graham Formula (Option exercised) Current (normal earnings) Expected annual growth rate (%) Number of shares Estimated price per share
$3,190.06 4.00
955.20
$41.75
$4,223.50 4.00
955.20
$55.27 41
Key decision driver
Upside
Possibility of synergy with Alliance Boots Strong same store sales growth Improvements in margins due to NYSE:ABC deal
Downside
Increased leverage Inadequate synergy with Alliance Boots Increased power of managed care providers influencing margins
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Valuation Results
Discounted cash flow Benjamin Graham's formula Relative valuation
Option not exercised
$45.15
$41.75 $45.83
Option exercised
$56.31
$55.27 -
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Recommendation
SELL
200 Shares @ Market Price
Expected gain $6,880 if sold at $59.40 per share
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