1. Walgreen Co. (Walgreens Boots Alliance)
Ricky Fang, Jacob Stoiber, & Kevin Farshchi
Presented October 30, 2014

2. Agenda Investment Thesis Macroeconomic Overview Industry Analysis
Walgreen & Its Business
Catalysts & Concerns (SWOT)
Financial Analysis
Valuation
Recommendation

3. Investment Thesis
Walgreens Boots Alliance is likely to become the principal retail pharmacy in the world
Our team is confident that recent financial results, merger valuation, and strategic initiatives demonstrate Walgreen is an attractive holding in the long term.
Granted, there is a chance the next few quarters/years may experience some tough adjustments and potential volatility, we are optimistic that long-term shareholders have an opportunity for increasing return on invested capital
The recent sales increases in conjunction with a strong balance sheet indicate that Walgreen is in a solid financial position to create opportunities for growth through its strategic acquisition of Alliance Boots
In conclusion, if we apply proper valuation and identify mispriced businesses, the market should agree with us in the long term and price should reflect fair value.

4. Transaction History & Current Position
Original purchase: 1000 $25/share; Date purchased: October. 6th (Cost basis: $ 25000)
Action 1: 500 shares 49.94/share; Date sold: September 20th, 2006
Action 2: 200 shares 60.35/share; Date sold: November 22nd, 2013
Current position: 300 shares trading at $62.83/ share as of October. 29th, 2014 (Cost basis: $18,849)

5. Macroeconomic Overview
Booming Domestic Economy and Weak Economy in Europe
GDP number: $14.41, 14.96,15.53,16.24,16.8 trillion from respectively with an estimate of trillion for 2014
GDP decomposition: Y=C+I+G+NX; Consumer spending grew for the first time since 2004.
Unemployment rate: 9.3%, 9.6%,8.9%, 8.1%, 7.4% in and 5.9% reported in Sep. 2014
Low economic growth rate/ recession features in Europe: (-4.5%, 2%, 1.6%,-0.4%,0.1% GDP growth rate in )
GDP growth rates -2.8%, 2.51%, 1.85%, 2.78%, 1.88% from , respectively
Source:
Source:

6. Macroeconomic Overview
Projected

7. Macroeconomic Overview
Healthcare insurance provider: private insurance, Medicare & Medicaid, Affordable Care Act (Obamacare)
Percentage of uninsured Americans dropped from 18% in 2013 to 13.4% in May 2014.
Federal funding for Medicare and Medicaid add up to $ billion in 2014 with roughly 4% annual growth
Medicare: Part of US social security program, targeting senior citizens(65+), guarantee access to healthcare insurance
Medicaid: Specifically target people with low income and limited resource
Obamacare: Features to guarantee everyone to healthcare insurance by implementing various regulations such as employer mandate (companies >50 employers and don’t offer health insurance to employees have to pay tax penalty)
nd Medicaid

8. Pharmacies & Drug Stores
Turk, Sarah. "IBISWorld Industry Report Pharmacies & Drug Stores in the US." IBIS. N.p., Aug Web. Oct <http%3A%2F%2Fclients1.ibisworld.com%2Freports%2Fus%2Findustry%2Fdefault.aspx%3Fentid%3D4620>.

9. Industry Analysis- Porter’s Five Forces
Rooms for smaller business;
Industry concentration
Threat of new entrants:
Medium
More usage of online-ordering
Face competition in general merchandise with supermarket
Threat of Substitutes:
High
Relatively for individuals
High because of the existence of public health insurance and PBM (Prescription Benefits Managers)
Bargaining Power of Buyers: Medium
Maintain by being industry giants
Strong, long-term relationship with suppliers
Bargaining Power of Suppliers:
Multiple competitors including other drug retail chain, supermarket, independent drug store, online drug ordering and mail-order drugs
Rivalry among existing Firms: High
PBM (Prescription Benefits Managers)= a third party administrator of prescription drug programs
Turk, Sarah. "IBISWorld Industry Report Pharmacies & Drug Stores in the US." IBIS., Aug Web. Oct <http%3A%2F%2Fclients1.ibisworld.com%2Freports%2Fus%2Findustry%2Fdefault.aspx%3Fentid%3D4620>.

10. Introduction to Walgreens
Walgreens primarily sells prescription and non-prescription drugs
The company also sells general merchandise: convenience and fresh foods, household items, personal care, photofinishing and beauty care.
Walgreens Co. and subsidiaries are the largest drugstore chain in the US
As of August 31, 2014 Walgreens operates 8,309 stores and accounted for net sales of $76.4 billion
Approximately 76% of the US population is within a 5 mile radius of a Walgreens store
Source: Walgreen Co., FY14 Form 10 K for the Period Ending August 31, 2014, p. 3, from accessed October 26, 2014

11. The Business Three main business segments GICS classification:
Prescription drugs (65% of net sales)
Non-prescription drugs (25% of net sales)
General merchandise (10% of net sales)
Distribution pipeline
Key Supplier: AmerisourceBergen
Buyers: pharmacy benefit managers (Express Scripts), private health systems, public healthcare sector
GICS classification:
Sector: Consumer Staples
Industry: Food and Staples Retailing
Sub-Industry: Drug Retail
Source: Walgreen Co., FY14 Form 10 K for the Period Ending August 31, 2014, p. 5, from accessed October 26, 2014

12. Management Gregory D. Wasson President and CEO
New executive members from Alliance & Boots: Stefano Pessina (Executive Vice Chairman), Ornella Barra (president and chief executive of global wholesale and international retail)
Two members of activist investor Jana Partners LLC will join the board
Walgreens appointed new CFO Timothy McLevish on August and he has a history of cost control and financial discipline
Management Focus
Three year “Next Chapter” Plan
Cost reduction initiative
Capital Allocation Policy
Three year “Next Chapter” Plan:
A differentiated retail experience that transforms retail model for health, wellness and changes the way women shop for beauty
Integrated pharmacy and health care that advance the role of pharmacists and provide access to innovative health care services
Global pharmaceutical services that reinvent the pharmaceutical value chain and deliver a seamless specialty pharmacy model
Cost reduction initiative:
Effort in corporate, field and store-level cost reductions targeted to achieve $1 billion in savings by end of fiscal 2017
“Walgreens has demonstrated strong focus on cost control as adjusted SG&A growth has slowed … and move forward integrating Walgreens and Alliance Boots.” Watson ( k item 7 MD&A)
Capital Allocation Policy:
Continue to invest in its core business such as driving organic growth
Pursuing strategic opportunities such as Mergers and Acquisitions
Maintain strong balance sheet and financial flexibility with commitment to solid credit rating and govern future capital allocation
Returning cash to shareholders by targeting a percent long-term dividend payout ratio and a new $3 billion share repurchase
"Walgreens Board of Directors Exercises Option to Complete Second Step of Strategic Partnership with Alliance Boots and Fully Combine Both Companies, Creating First Global Pharmacy-Led, Health and Wellbeing Enterprise." Walgreen Co. N.p., 06 Aug Web. 29 Oct <

13. Management – key points
1. Moody’s rating downgraded their credit rating of subordinated debt 2. Ex-CFO dispute 3. Concerns for stock repurchases 4. Still need to wait to see how synergies are realized 5. Concerns for new executives: board members for Jana 6. Decision to not complete tax inversion disappointed investors back in September

14. Walgreens (NYSE: WAG) Price: $62.83 Beta: 0.964
Market Cap: Billion
Shares outstanding M
Dividend Yield: 2.15%
EPS: $2.00
52 week high: 76.39
52 week low: 54.86
Data assessed from Bloomberg Terminal

16. We can think of a 200 day as a trading year and a 20 day as a month

17. Alliance Boots Acquisition
On August 2, 2012, Walgreens acquired a 45% equity stake in Alliance Boots GmbH
On August 5, 2014, the Purchase and Option Agreement was amended to permit the exercise of the call option and Walgreen exercised the call option on August 5, 2014
The company will have over 11,000 stores across the US, Asia, and the EU as a result
“Immediately prior to the reorganization, shareholders will become shareholders of Walgreens Boots Alliance, with shares of Walgreen Co. common stock being converted automatically into shares of Walgreens Boots Alliance common stock on a one-for-one basis.”
Source: Walgreen Co., FY14 Form 10 K for the Period Ending August 31, 2014, p. 10, from accessed October 26, 2014

18. Strengths/Catalysts
Predicted growth of retail and prescriptions sales based on macro assessment
Aging population, ACA, and stronger US economy
Strong recent financial results
(Discussed later)
Partnerships create a global powerhouse
AmerisourceBergen ten-year distribution agreement established the world’s largest buyer of prescription drugs
Express Scripts, the largest global PBM, will increase customer base
Alliance Boots acquisition: cost synergies and addition to top line in the long term
Combined synergies across both companies were approximately $491 million in fiscal 2014 and management estimates fiscal year 2015 combined synergies to be $650 million.
Walgreen reported its biggest jump in quarterly sales in three years on Tuesday, driven by a 9.3 percent rise in prescription sales in the fourth quarter.
Also have a minority interest in ABC
Walgreens filed ~699 million prescriptions in FY 2014 (an increase of 16 million from FY 2013)
"Walgreens Board of Directors Exercises Option to Complete Second Step of Strategic Partnership with Alliance Boots and Fully Combine Both Companies, Creating First Global Pharmacy-Led, Health and Wellbeing Enterprise." Walgreen Co. N.p., 06 Aug Web. 29 Oct <

19. Risks/Concerns
Slowdown of discretionary spending will disrupt front-end sales of general merchandise
Seasonality of business
Second fiscal quarter has much higher-front end sales due to the cough, cold, and flu season
Operating leases can be viewed as debt
The balance sheet does not reflect this liability
Risk of PBM’s
Partnership with AmerisourceBergen may not be realized to full potential
Alliance Boots synergies and revenue stream may not come to fruition
The goals of this acquisition will take time to achieve
Exposure to EU: exchange rates, economic recession, government regulation are a few issues
Dilution
After the second step transaction, Walgreens shareholders will own a smaller percentage of Walgreens Boots Alliance common stock than they currently own.
Summary of Quarterly Results (Unaudited)" in Part II, Item 8 of this Form 10-K
Source: Walgreen Co., FY14 Form 10 K for the Period Ending August 31, 2014, p. 10, from accessed October 26, 2014

20. Risks/Concerns
Slowdown of discretionary spending will disrupt front-end sales of general merchandise
Seasonality of business
Operating leases can be viewed as debt
The balance sheet does not reflect this liability
Risk of PBM relationships in the future
Partnership with AmerisourceBergen may not be realized to full potential
Alliance Boots synergies and revenue stream may not come to fruition
The goals of this acquisition will take time to achieve
Exposure to EU: exchange rates, economic recession, government regulation are a few issues
Dilution
After the second step transaction, Walgreens shareholders will own a smaller percentage of Walgreens Boots Alliance common stock than they currently own.
Second fiscal quarter has much higher-front end sales due to the cough, cold, and flu seaso
Source: Walgreen Co., FY14 Form 10 K for the Period Ending August 31, 2014, p. 10, from accessed October 26, 2014

21. Recent Financial Results
Sales for September were $6.48 billion for FY 2015, an increase of 9.4%
Comparable store sales increased by 7.9% during the month.
Pharmacy sales accounted for 67.8% of total sales, and increased by 14.2%.1
Fiscal Year 2014 sales increased 5.8 percent to record $76.4 billion;
Sales for September in FY 2015 increased 9.4% at $6.48 billion, an increase of 9.4% from $5.82 billion for the same month in fiscal 2014;
Gross margin decreased to 28.2% in 2014 from 29.2%
Met fourth quarter earning estimate(Adjusted EPS increased 1.4% to 74%)
1 "Walgreens September Sales Increase 9.4 Percent." Walgreen Co. N.p., 03 Oct Web. 29 Oct <

22. Financial Analysis - Liquidity
2010
2011
2012
2013
2014
Current Ratio
1.604
1.524
1.234
1.337
1.376
Quick Ratio
0.611
0.529
0.427
0.565
0.693

23. Financial Analysis - Solvency
2010
2011
2012
2013
2014
Debt/Assets
0.091
0.088
0.161
0.142
0.121
Interest Coverage
40.682
61.479
39.364
23.879
26.885

24. Financial Analysis - Profitability
2010
2011
2012
2013
2014
Gross Margin
28.15%
28.39%
28.40%
29.24%
28.23%
ROA
8.13%
10.10%
6.98%
7.11%
5.32%
ROE
14.52%
18.28%
11.66%
12.59%
9.44%

25. Financial Analysis - DuPont
DuPont Analysis
2010
2011
2012
2013
2014
Tax Burden
0.620
0.632
0.630
0.629
0.571
Interest Burden
0.975
0.984
0.989
0.848
Operating Profit Margin
0.051
0.060
0.048
0.055
Asset Turnover
2.566
2.629
2.141
2.035
2.055
Leverage
1.825
1.849
1.835
1.824
1.818
ROE
14.52%
18.28%
11.66%
12.59%
9.93%

26. Financial Analysis - Efficiency
2010
2011
2012
2013
2014
A/R Turnover
27.518
28.908
33.056
27.438
23.739
A/P Turnover
14.704
15.007
16.340
15.581
17.704
Inventory Turnover
9.138
8.974
10.181
10.540
12.573
Days Sales Outstanding (DSO)
13.264
12.626
11.042
13.303
15.376
Days Payable Outstanding
24.822
24.322
22.338
23.426
20.617
Days Inventory Outstanding
39.943
40.675
35.851
34.631
29.031
Cash Conversion Cycle
28.385
28.979
24.555
24.508
23.790

27. Financial Analysis – Joel Greenblatt
Joel Greenblatt Ratios
2010
2011
2012
2013
2014
EBIT/Tangible Assets
0.250
0.307
0.246
0.290
0.305
EBIT/EV
0.049
0.061
0.047
0.053
0.057

28. Discount Rate Returns n 60 Risk Free Rate 2.37% µ 1.376% σ 0.083
2.37%
1.376% σ
0.083
WAG Annualized Return
17.82%
CAPM Approach Rf
Beta
0.964
MRP
7.29%
E[r] Equity
9.398%
Blended E[R]
15.713%
Cost of Debt
Capital Structure Summary
Total Interest Expense
156.00
Total Debt
28,024.0
57.7%
4,510.00
Total Common Equity
20,457.0
42.1%
3.46%
Total Minority Interest
104.0
0.2%
Marginal Tax Rate
37%
Total Capital
48,585.0
100.0%
Tax Effected Cost of Debt
2.18%
WACC
7.87%
Business Risk Premium 1%
Discount Rate
8.87%

29. Assumptions Select a Case: Base Case Revenue Assumptions FY 2015
Boom Case
5.00%
9.00%
7.00%
Revenue Growth
3.0%
7.0%
5.0%
Gross Profit Margin
29.5%
32.0%
35.0%
Bust Case
1.0%
SG&A as a % of Sales
22.5%
Interest Expense/Operating Income
3.5%
4.0%
4.5%
Tax Rate
37.0%
Depreciation
10.0%
Capital Expenditures
2.0%
1.7%
Total Assets as a % of Revenue
44.4%

30. Discounted Cash Flow Valuation
FCF Build - WAG
EBIT
$5,507.86
$7,998.20
$11,260.63
$11,823.66
$9,255.56
9,255.56
Less: Taxes
1,976.77
2,855.76
3,999.78
4,177.89
3,253.33
Less: Capex
1,573.68
1,431.26
1,531.45
1,608.02
1,656.26
1,829.34
Less: Changes in NWC
1,983.99
242.13
259.08
198.01
124.75
Plus: D&A
1,477.41
1,580.83
1,691.48
1,776.06
Unlevered FCF
1,450.83
5,049.88
7,161.81
7,615.80
6,050.57
6,002.23
FCF Build - BOOTS
1,929.69
2,064.77
2,209.30
2,319.77
2,389.36
8.90
9.52
10.19
10.70
11.02
Less: CAPEX
463.71
496.17
530.90
557.45
574.17
774.58
(45.41)
(45.83)
(46.25)
(46.67)
(47.09)
625.56
669.35
716.21
752.02
2,128.05
2,274.25
2,430.66
2,550.30
2,625.84
2,378.34
Terminal Value Assumptions 3%
Discount Rate (WACC + premium)
8.87%
Terminal Value WAG
105,264.94
Terminal Value (WAG + BOOTS)
27,608.08
Discount Period (t) 1 2 3 4 5
PV of FCF's (WAG)
1,332.59
4,260.30
5,549.60
5,420.43
3,955.43
68,814.68
PV of FCF's (WAG + BOOTS)
3,287.21
6,178.96
7,433.08
7,235.56
5,672.01
18,048.19
PV of FCF's
Terminal Value
Equity Value
Enterprise Value
Net Debt
DSO
$/Share
Perpetuity Method (WAG ONLY)
20,518.34
51,844.02
89,333.02
37,489.01
965.2 $
Perpetuity Method (WAG + BOOTS)
50,325.17
86,862.87
81,612.53
137,188.04
55,575.51 $

31. Comparables Valuation
Company Name
Weight
TEV
EBITDA
EBIT
Revenue
TEV/EBITDA
TEV/EBIT
TEV/Revenue
CVS Health Corporation
70%
8545.0
10.6x
12.9x
0.8x
Rite Aid Corporation
20%
1157.9
750.1
9.1x
14.0x
0.4x
Wal-Mart Stores Inc. 8%
8.4x
11.3x
0.6x
Express Scripts Holding Company 2%
5802.7
3726.0
11.9x
18.6x
0.7x
100%
Walgreen Co.
5141.0
3936.0
12.2x
15.9x
High
Low
Median
8115.9
6135.5
9.8x
13.5x
Mean
9902.8
10.0x
14.2x
Weighted Average
10.1x
13.1x
EV/EBITDA
EV/EBIT
EV/REVENUE
Enterprise Value
Less: Total Debt
4,510
Plus: Cash
2,646
Equity Value
50,302
49,824
53,943
Total Shares Outstanding
950
Intrinsic Value/Share
$52.93
$52.42
$56.76
Average Value/Share
$54.04
Median Value/Share

32. Price Targets DCF: WAG + BOOTS = $84.56 (23.26% return)
DCF: WAG only =$53.71
Comps (average) = $54.04

33. Our Recommendation
HOLD