Walgreen Co.

1
Walgreen Co.

• (WAG)
• Presented April 19, 2007

2
Investment Managers

• Jessica Boghosian
• jboghos2_at_uiuc.edu
• Shengdong Zhu
• szhu4_at_uiuc.edu

3
Company Overview

• Incorporated in 1909, headquartered in Deerfield,
  Illinois.
• Nations largest drugstore based on sales
• Engaged in the retail sale of prescription and
  non-prescription drugs and general merchandise
  including beauty care, personal care, household
  items, candy, photofinishing, greeting cards,
  seasonal items, and convenience foods.
• Recorded its 32nd year of consecutive earnings
  and sales growth.
• During the year, Walgreen Co. had a net increase
  of 476 stores, totaling to 5,461 stores located
  in 47 states and Puerto Rico.

4
Company Overview

• Success is dependent upon continuously opening
  new Walgreens stores.
• Walgreen Co. plans to operate more than 7,000
  stores by 2010.
• Walgreen Co. is in the business of strategically
  locating new stores as well as relocating/closing
  existing stores.

5
New Walgreens Co. Stores
Fiscal Year of New Stores
2000 462
2001 474
2002 471
2003 430
2004 436
2005 435
2006 570

• Over the past 7 years, Walgreen Co. has opened on
  average 1.28 stores/day.

6
National Store Distribution

• Walgreen Co. has made it a point to open the most
  stores in the states that are the popular
  locations for aging baby boomers to retire.

Image Walgreen Co. Annual Report 2006
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Product Class Attribution to Sales
Fiscal Year 2006 Fiscal Year 2005 Fiscal year 2004
Prescription Drugs 64 64 63
Non-Prescription Drugs 11 11 12
General Merchandise 25 25 25
8
Pharmacy Sales

• Pharmacy sales continue to become a larger
  portion of Walgreens business.
• Walgreens filled 529 million prescriptions in
  2006, totaling to an increase of 8.1 from the
  2005 fiscal year.
• Sales trends are expected to continue to grow for
  the following reasons
• Aging population
• Introduction of lower priced generics
• Continued development of innovative drugs

9
Medicare Part D

• Medicare Part D is a government initiated program
  to subsidize the costs of prescription drugs to
  individuals covered by Medicare. Part D was
  implemented in January of 2006.
• Walgreens has obtained a larger share of senior
  citizen patients due to this program.
• 35 of the prescriptions filled under this
  program in the first eight months were new
  customers to Walgreens.

10
New Developments

• Dial-a-Pharmacist
• Available in 14 languages, this system allows
  customers to discover where there is a Walgreens
  pharmacist that speaks his or her language.
• Solar Power Usage
• 100 stores utilize solar energy, making Walgreens
  the largest retail user of this source of energy.
• Highway Signs
• A new federal law allows signs to be placed on
  highways informing drivers of the location of 24
  hour pharmacies. Several have already been
  planted with many more to come.

Source Walgreen Co. Annual Meeting, January 2006
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Corporate Risk

• Walgreen Co. faces intense competition with
  local, regional, and national companies, many of
  which are infiltrating Walgreens existing
  markets.
• Extreme competition can have an adverse affect on
  prices.
• Third-party payors of prescription drugs are
  attempting to reduce costs and pharmacy
  reimbursement rates.
• On February 8th, 2006, President Bush signed the
  Deficit Reduction Act of 2005
• This Act will ultimately reduce Medicaid
  reimbursement rates to retail pharmacies.
• Further reduction in these rates are foreseeable.

12
RCMP Position

• Originally owned 1000 shares of WAG, purchases on
  October 6th, 1999 for 25.00/share.
• On September 20th, 2006, 500 shares were sold _at_
  49.94/share for a realized gain of 12,470.
• Currently own 500 shares of WAG, trading at
  45.96 as of April 19, 2007 for an unrealized
  gain of 10,480 or 83.84.

13
Role in Portfolio

• Walgreen Co. currently comprises 7 of our
  portfolio.

14
Correlation Matrix
15
5-Year Growth vs. SP 500
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Competitors

• Who
• CVS/Caremark Corp. (CVS)
• Rite Aid Corp. (RAD)
• Why
• Industry Specific
• Business Segment Specific (prescription and
  non-prescription drugs and general merchandise)

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Out-performing Its Competitors

• Prescription Volume

WALGREEN CO. 263/day
Chain Drugstores 180/day
Mass Retailers 143/day
Grocery 131/day
Independents 100/day
Source Walgreen Co. Annual Meeting, January 2006
18
Out-performing Its Competitors

• Earnings per square foot

WALGREEN CO. 46
Chain Drugstores lt23
Grocery 12
Source Walgreen Co. Annual Meeting, January 2006
19
1-Year Comparables
20
5-Year Comparables
21
Comparable Analysis
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Assumptions

• Organic growth continues to be the primary growth
  vehicle
• Future growth was estimated assuming to be in
  line with increasing medical costs and increasing
  store numbers.
• We assume that future growth will continue at a
  13 annual rate but will gradually decrease to 9
  over the next five years and then remain at a 3
  annual growth rate thereafter

23
Discounted Cash Flow Analysis
?
24
Discounted Cash Flow Analysis

• Since Walgreen Co. is 100 equity financed,
  WACCke.
• Beta Regression 0.1 vs. Bloomberg .66
• Average .4

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Discounted Cash Flow Analysis
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A Note On Capital Structure

• Walgreen Co. is an all equity financed firm.
• The company owns a mere 18 of its store base.
  The other 82 is leased.
• These leases hold Walgreen Co. responsible for
  26.078 billion, but this obligation is not seen
  on the balance sheet as a liability to the firm.
• This poses potentially risk to Walgreen Co.
• Lets call these lease obligations quasi-debt.
• THEREFORE, it is important to keep in mind this
  accounting structure when valuing WAG.

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Sensitivity Analysis
Most likely to range from 34.73 to 57.04
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Portfolio Fit

• Sharpe Ratio
• a measure of the mean excess return per unit of
  risk in an investment asset or a trading strategy
• Including WAG generates a higher Sharpe Ratio

29
RCMP Fall 06 Decision

• 500 Shares of WAG were sold last semester at
  49.94. Why?
• Lease Obligations
• WACC was adjusted upward based on the risk of
  outstanding lease obligations
• After this adjustment, the company appeared to be
  trading at a significantly inflated price that,
  in the long term, could not be sustained.

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Recommendation

• HOLD.
• Why?
• Healthy management vision
• Stable, growing company
• Solid performer
• Leader in its class
• But what about these lease obligations and other
  business risks!?
• Acknowledge that every company has risk, with
  Wagreen Co. as no exception.
• We have already taken action as conservative
  investors by selling 500 shares.