Analyst view: New Walgreens Boots Alliance poised for growth in fiscal 2016 powered by front-end margin gains

NEW YORK — Walgreens may be in a year of transition through 2015 with the closing of the Alliance Boots transaction, continued pharmacy reimbursement pressures and the implementation of expense reduction initiatives, but the company is poised for multiyear improvement beginning in 2016, noted analyst Mark Miller of William Blair, who met with top Walgreens executives last week.  

 

"Walgreens has taken positive steps putting the right people in place, there is now a clear sense of urgency and we believe the company will implement tight cost controls to protect earnings and cash flow until the key strategies and initiatives take hold," Miller wrote. Those key strategies include SKU rationalization, more shelf-ready items, fewer promotions and aligning category resets with seasonal changeovers. 

 

Walgreens is expected to model the Boots experience, Miller noted, by taking advantage of margin-expansion opportunities across the front end even as the margin continues to be challenged across the back bench. 

 

Over the course of the meeting, Alex Gourlay, Walgreens president of customer experience and daily living, identified four strategies to expand margin across the front end, including stocking the front end with seasonal gifting items of less than $20, accommodating fill-in grocery trips, focusing on "instant consumptions" with candy, breakfast and lunch and showcasing "tech and go" mobile accessories.

 

 

"Front-end margins have actually begun to improve year-over-year over the past two quarters, although this has been overshadowed by reimbursement challenges in the pharmacy," Miller noted. "The Boots playbook is providing guidance, although management is mindful that the Walgreens store experience must evolve differently in the U.S. consumer environment. Still, the company wants to replicate many elements of the Boots model, including the high-touch service and enhanced beauty offering," he wrote. "This model is not adaptive to all markets, but management believes it can work in about 2,000 store locations (or roughly 25% of the base)."

 

Walgreens' historical focus on building homogenous stores on the corners of Main and Main is giving way to localization and personalization driven by learnings from the Balance Rewards loyalty card program, taking another page out of the Boots playbook.

 

Miller projected Walgreens will post declines in pharmacy margins through fiscal 2015. "The main headwinds from fiscal 2014, including reimbursement pressure, Medicare Part D contracting and generic inflation, are expected to persist through fiscal 2015 and into fiscal 2016," he wrote. "The step down in Medicare Part D rates beginning Jan. 1 was not anticipated by management in its original long-term forecast, although we do not perceive there are additional adverse developments since this issue was disclosed this summer."

 

In response to the generic reimbursement challenge, Walgreens has conducted an extensive analysis of generic molecules by manufacturer to anticipate which drugs could experience hyper-inflation and when, Miller noted. 

 

Following the consolidation of Walgreens and Alliance Boots, Walgreens CFO Timothy McLevish will focus on operational execution as Stefano Pessina, executive chairman, leads all M&A activity and strategy for the combined company, Miller added.