The market sold-off shares of Walgreen Co. (WAG) following the release of November sales data to the tune of about 4% in afternoon trading. We do not regard the sales results as particularly bad, coming in at nearly $5.4 billion which is 8.7% higher than year ago totals. Some of that improvement was due to new stores opening in the past year, but even same store sales improved by 3.9%. Even so, the results fell well short of analysts’ expectations of 6.1% rise in same store sales, and falling below those expectations is what sparked the selling. Considering the stock’s impressive and consistent gains, any disappointment was sure to be met with at least some profit taking.
In general, sales of prescriptions performed better than general merchandise, although neither category lived up to expectations. Pharmacy sales rose by 5.8% in comparable stores; aided by consumers filling 90-day prescriptions which counts all three months sales into the current period. General merchandise has been a focal point for Walgreen’s management recently as they have reduced clutter and tried to stock only essentials. The front-end of stores was only able to manage .8% improvement to comparable sales in the month and noted that Thanksgiving weekend was softer than expected. Analysts had hoped that the new strategy would be more positively received and lead to same store sales gains of 3.8%.
At Ockham, we continue to view Walgreen’s as Undervalued and are not deterred by one month’s disappointment. One month’s data is not a trend, and looking at a longer term view of Walgreen’s shows sales the trends are headed in the right direction. More importantly, even after the stock has enjoyed a nice run of late, it is still attractively valued compared to what the market has historically been willing to pay. For example, over the past ten years the market has been willing to pay between 17.6x and 24.6x cash earnings per share, but at current levels WAG trades at a price-to-cash earnings level of 13.0x. The stock looks similarly Undervalued from the prospective of price-to-sales which is currently only .61x, whereas the historical range over the last ten years is .85x all the way up to 1.2x. We think it is very reasonable to think that Walgreen’s will at least come closer into line with these historical valuation ranges.
According to our methodology, value investors should consider WAG on the dips because if the market valued it as it has historically, WAG could easily hit $50 over the next year. In addition, management has a proven track record of consistently raising dividends for the past 34 years in a row. In conclusion, we are reaffirming our Undervalued stance on WAG despite a less impressive performance in November. Investors focused on income or value could do far worse than the nation’s largest drugstore chain.