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Date: November 21, 2013 Jun Yuan (Jason) Chan Hisham Haider Dewan Zige (Z) He Charalampos (Haris) Ntantanis 1.

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Presentation on theme: "Date: November 21, 2013 Jun Yuan (Jason) Chan Hisham Haider Dewan Zige (Z) He Charalampos (Haris) Ntantanis 1."— Presentation transcript:

1 Date: November 21, 2013 Jun Yuan (Jason) Chan Hisham Haider Dewan Zige (Z) He Charalampos (Haris) Ntantanis 1

2 2 Agenda  Holding Information  Company overview  Macro-economic overview  Industry analysis  Equity market performance  Financial analysis and projections  Valuation  Recommendation

3 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 = % Annually compounded return = 6.377% Allocation of portfolio = 14.75% Current Holdings Source: Yahoo Finance; *$59.40 per share as of Nov 20, 2013

4  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 Introduction to Walgreen (NYSE:WAG) Source: Walgreen Co K filing Item 1. Business

5 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 K filing Item 1. Business

6 6 Revenue Breakdown by Segment Source: Bloomberg terminal Walgreen Co. revenue breakdown by segment

7 Location Type Drugstores Worksite Health and Wellness Centers Infusion and Respiratory Services Facilities Specialty Pharmacies911 Mail Service Facilities222 Total Distribution Network Source: Walgreen Co K filing Item 1. Business 6.2 million daily visits to stores in 2013

8  Mobile  Alliance Boots expands into Europe  New store through M&A  Online eCommerece  Mail order 8 Distribution Network

9 9 Annual Revenue Source: Walgreen Co. 10K filing from 2007 to 2013 Statement of Earnings

10 10 Annual Net Income Source: Walgreen Co. 10K filing from 2007 to 2013 Statement of Earnings

11 11 Same Store Sales Growth Source: Susquehanna Financial Group, LLLP (SFG) Research Walgreen Company Update October 3, 2013, page 3

12  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) 12 Mergers, Acquisition and Partnerships Source: Walgreen Co K filing Item 1. Business - Business Development

13  WAG has 45% investment in Alliance Boots at $6, Mil giving WAG access to EU markets 13 Equity Stake of Alliance Boots

14 About Alliance Boots 14 Source: Alliance Boots Annual Report page 1-2

15  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 Option to Buy Alliance Boots Source: 1. Capital IQ; 2. Author’s estimation; 3. Walgreen Co K filing Item 1A. Risk Factors and based on exchange rates as of March 31, 2013 (Approximately £6.7 billion); 4.

16  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 16 Dispute Resolution with Express Scripts Source: Walgreen Co K filing Item 1A. Risk Factors

17 17 Equity Performance Source: Google Finance

18 18 Technical Analysis Source:

19  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 19 Macro-economic Overview Source: 1. IBISWorld Industry Report 33451b Medical Device Manufacturing in the US October 2013, page Source: OECD. Health Data Frequently Requested Data. frequentlyrequesteddata.htm 3. frequentlyrequesteddata.htm

20 20 Macro-economic Outlook

21 21 Drug Retail Industry Source: IBISWorld Industry Report Pharmacies & Drug Stores in the US, Page 4

22 1.Disposable income rising 2.Aging population (13.7% of the U.S. population is over 65) 3.Number of people covered by private health insurance (49.1 Mil. or 16% of the U.S. population uninsured) 4.Number of physician visits expected to increase 22 Industry Growth Drivers

23 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 23 Source:

24  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 Risks

25 Porter’s Five Forces for Walgreen Threat of new entrant: High Bargaining power of buyer: High Threat of substitute product: Medium Bargaining power of supplier: Medium Competitive Rivalry: High 25

26  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 26 Management Outlook and Performance Source: Walgreen Company WAG Q Earnings Call Transcript

27 Company Life Cycle 27 Source:

28 28 Walgreen SWOT Analysis Strong brand awareness Distribution network Diversified retail channels Strengths High operating leverage (lease) Exposure to weak EU economy Weaknesses Strategic acquisitions and expansions Growth of online retailing Rising healthcare expenditure Latent demand for beauty products Opportunities Global economic slowdown Stringent government regulations Highly competitive industry Lack of synergy after acquisitions Threats

29 Financial Analysis Ratio Analysis, DuPont Analysis, Lease 29

30 30 Ratio Analysis Liquidity Ratios2009A2010A2011A2012A2013A Current Ratio Quick Ratio Cash Ratio Solvency Ratios2009A2010A2011A2012A2013A Debt/Assets Debt/Equity Interest Coverage Activity Ratios2009A2010A2011A2012A2013A A/R Turnover Fixed Asset Turnover Total Asset Turnover

31 Greenblatt Ratios2009A2010A2011A2012A2013A EBIT/Tangible Assets14.32%15.11%16.64%15.37%15.07% EBIT/EV Ratio Analysis Profitability Ratios2009A2010A2011A2012A2013A Operating Profit Margin5.13% 6.05%4.84%5.46% Net Margin3.17%3.10%3.76%2.97%3.39% ROA7.98%7.96%9.89%6.36%6.91% ROE (Book Value)13.95%14.52%18.28%11.66%12.59%

32 32 DuPont DuPont Analysis2009A2010A2011A2012A2013A Tax Burden Interest Burden Operating Profit Margin 5.127%5.129%6.047%4.836%5.456% Asset Turnover Leverage ROE 13.95%14.52%18.28%11.66%12.59%

33 Walgreens Leases Walgreens owns approximately 20% of its operating locations; the remaining locations are leased premises. Initial terms are typically 20 to 25 years. Capital Leases (in $mil)Operating Leases (in $mil) $2, , , , ,292 Later27023,507 Total minimum lease payment$358$35,702

34 Valuation DCF, Relative valuation, Benjamin Graham formula 34

35 35 Cost of capital Weighted average cost of debt2.76%Weights Cost of equity using CAPM8.04%70.00% ROE (5 year average ROE)14.10%30.00% Cost of equity using goal post method9.86% Market value of debt5, Market value of equity57, Weight of debt8.15% Weight of equity91.85% Tax rate35.00% Calculated WACC9.20% Business Risk Premium1.00% Adjusted WACC 1 (Calculated WACC + Business Risk Premium) 10.20% Beta (From 1/3/2012 to 11/11/2013) Market risk premium (Rm-Rf)6.00% 10 year treasury yield2.66% Cost of equity using CAPM8.0429%

36 36 Free Cash Flow to Firm (Option Not Exercised) 2014P2015P2016P2017P2018P EBIT4, , , , , Less: Income Taxes1, , , , , Plus: D&A1, Less: CapEx1, Less: Change in Working Capital FCFF to WAG 1, , , , , FCFF to AB $593.84$611.66$630.01$648.91$ FCF used in DCF 2, , , , ,546.71

37 37 Free Cash Flow to Firm (Option Exercised) 2014P2015P2016P2017P2018P EBIT4, , , , , Less: Income Taxes1, , , , , Plus: D&A1, Less: CapEx1, Less: Change in Working Capital FCFF to WAG 1, , , , , FCFF to AB $593.84$1,359.24$1,400.02$1,442.02$1, FCF used in DCF 2, , , , ,363.62

38 Option Exercised WACC10.203% Terminal Value (at 2018) $73, Terminal Growth Rate4.00% Implied Enterprise Value $58, Plus: Cash Less: Debt$5, Value of equity $53, Shares Outstanding Estimated price per share $56.31 Option Not Exercised WACC10.203% Terminal Value (at 2018) $59, Terminal Growth Rate4.00% Implied Enterprise Value $ 48, Plus: Cash Less: Debt$5, Value of equity $43, Shares Outstanding Estimated price per share $ DCF Valuation

39 39 Comparable Companies Company NameMarket Capitalization RevenueSubjective weight AmerisourceBergen Corporation (NYSE:ABC) 15, , % Cardinal Health, Inc. (NYSE:CAH) 21, , % CVS Caremark Corporation (NYSE:CVS) 77, , % Express Scripts Holding Company (NasdaqGS:ESRX) 53, , % Omnicare Inc. (NYSE:OCR) 5, , % Rite Aid Corporation (NYSE:RAD) 4, , % Safeway Inc. (NYSE:SWY) 8, , % Walgreen Co. (NYSE:WAG) 57, ,437.34

40 40 Relative Valuation Implied Price per Share Weighted average (using subjective weights for companies) $45.83 Multiple value*Implied price per share TEV/Total Revenues0.5x $37.33 TEV/EBIT12.2x $46.88 TEV/EBITDA9.2x $43.17 TEV/Forward Total Revenue (Capital IQ)0.5x $38.79 TEV/Forward EBITDA (Capital IQ)8.8x $47.95 P/Diluted EPS Before Extra24.1x $60.44 Forward P/E (Capital IQ)16.9x $61.16 Price/Sales0.4x $30.92 *Using subjective weights for companies

41 41 Benjamin Graham's Formula Ben Graham Formula (Option not exercised) Current (normal earnings) $3, Expected annual growth rate (%) 4.00 Number of shares Estimated price per share $41.75 Ben Graham Formula (Option exercised) Current (normal earnings) $4, Expected annual growth rate (%) 4.00 Number of shares Estimated price per share $55.27

42 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 42 Key decision driver

43 Option not exercisedOption exercised Discounted cash flow$45.15$56.31 Benjamin Graham's formula $41.75$55.27 Relative valuation$ Valuation Results

44 44 Recommendation 200 Market Price Expected gain $6,880 if sold at $59.40 per share SELL


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