Walgreens Boots Tops Q3 Earnings, Rite Aid Deal On Track

Walgreens Boots Alliance, Inc. (NASDAQ:WBA) reported adjusted earnings per share (EPS) of $1.18 in the third quarter of fiscal 2016, up 15.7% from the year-ago adjusted number. Adjusted EPS also beat the Zacks Consensus Estimate by 3.5%.

A single-digit growth observed in the company’s top line number primarily drove the improvement in adjusted earnings.

On a reported basis, net earnings came in at $1.1 billion or $1.01 per share, reflecting a decline of 15.3% or 14.4% respectively, from the year-ago quarter.

Total Sales

Walgreens Boots recorded total sales of $29.5 billion in the fiscal third quarter, up 2.4% year over year or 3.3% at constant exchange rate (CER). However, the top line missed the Zacks Consensus Estimate of $29.9 billion.

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 $21.2 billion in the reported quarter, reflecting an increase of 3.7% on a year-over-year basis. Within this segment, total sales in comparable drugstores increased 3.9%, while prescriptions filled in comparable stores grew 4.5% on account of continued growth in Medicare Part D volume. On the other hand, comparable retail stores grew 0.1%, driven by higher sales in the health and wellness and photo categories.

Pharmacy sales, which accounted for 67.4% of the division’s sales in the quarter, increased 5.8% from the year-ago quarter, while pharmacy sales in comparable stores climbed 6%.

Revenues from the Retail Pharmacy International division dropped 2.3% on a year over year basis (up 3.4% at CER) to $3.2 billion, on account of currency fluctuations. At CER, comparable store sales in the third quarter increased 0.2% year over year, while comparable pharmacy sales dropped 0.7% – partly driven by expected reduction in the U.K.’s pharmacy funding and the loss of certain institutional sales contracts in Chile.

The Pharmaceutical Wholesale division recorded quarterly sales of $5.7 billion, up 0.7%.At CER, excluding acquisitions and dispositions; comparable store sales improved 6.3%

Margins

Gross profit improved 0.2% year over year to $7.5 billion and adjusted gross profit improved 0.5% to $7.6 billion. However, reported gross margin dropped 60 basis points (bps), while adjusted gross margin declined 50 bps in the fiscal third quarter.

Adjusted selling, general and administrative (SG&A) expenses dropped 0.3% to $5.8 billion. Consequently, adjusted operating income increased 3.3% to $1.8 billion owing to higher gross profit and lower operating expense. However, adjusted operating margin remained approximately flat at 6.1%.

Financial Condition

Walgreens Boots exited the reported quarter with cash and cash equivalents of $3.3 billion, compared to $3.6 billion in the second quarter of fiscal 2016. Long-term debt was $13.2 billion, compared with $13 billion in the prior quarter.

Moreover, the company generated operating cash flow of $5.2 billion in the reported quarter compared with $4.2 billion a year ago. The resultant free cash flow was $1.9 billion.

Guidance

Walgreens Boots has once again raised the lower end of its EPS guidance for fiscal 2016. The company currently expects adjusted EPS in the $4.45–$4.55 range for the full fiscal, as against the earlier guided $4.35–$4.55. The current Zacks Consensus Estimate for fiscal 2016 earnings is $4.49, within the company’s guidance range.

This guidance assumes no impact from the proposed acquisition of Rite Aid and related financing and assumes current exchange rates for the rest of fiscal 2016.

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. Management continues to expect the transaction 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.

On Jun 1, 2016, in order to partially fund this deal, Walgreens Boots completed a public offering of $6 billion aggregate principal amount of unsecured, unsubordinated notes with varying maturities and interest rates. Management expects this transaction to be accretive to its adjusted EPS in its first full year after completion.

Our Take

Walgreens Boots reported a mixed third-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 four quarters as well. On a brighter note, the company continues to hold a strong cash balance position 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, the recently completed public offering of notes, in order to fund the Rite Aid deal, will increase the company’s long-term liabilities.

Nevertheless, Walgreens Boots was successful in achieving its earlier set target of achieving combined net synergies of at least $1 billion, on account of the legacy Walgreens’ merger with Alliance Boots; in June 2016.

Zacks Rank

Walgreens Boots currently has a Zacks Rank #3 (Hold). Some other well-ranked stocks in the medical sector are GW Pharmaceuticals plc (NASDAQ:GWPH) , ICU Medical, Inc. (NASDAQ:ICUI) and TG Therapeutics, Inc. (NASDAQ:TGTX) . All these stocks sport a Zacks Rank #1 (Strong Buy).