Pushing back against sour economy, Walgreens broadens marketing effort

DEERFIELD, Ill. If Walgreens is a bellwether for the U.S. economy, that bell is ringing a warning.

Walgreens reported its 34th consecutive year of record sales and earnings Sept. 29, with net profits rising 5.7 percent to $2.16 billion in the fiscal year ending Aug. 31 and sales up 9.8 percent to $59.0 billion. In the final quarter of fiscal 2008, net income rose 11.7 percent over prior-year levels to $443 million, and sales increased 8.8 percent to a record $14.6 billion.

“We continue to build strong sales and profits, despite the challenging economy,” said Walgreens chairman and chief executive officer Jeff Rein. “Millions of loyal customers are responding every day to our core offerings of overall value and convenience. In fact, we recorded share growth in 58 of our top 60 product categories compared to food, drug and mass merchandise competitors as measured by A.C. Nielsen.”

All well and good, but behind the gains is a picture of one of drug store retailing’s premier companies pushing hard against the headwinds of a souring economy and a pullback in spending that is hammering both prescription and front-end business. Thus, fourth-quarter prescription volumes rose a paltry 0.6 percent on a same-store basis—still better than the 1.9 percent decrease in U.S. retail script volume recorded by IMS Health during the period but low by Walgreens’ standards.

“Tough times are forcing people to make tough choices—delaying doctor visits and prescription use,” said Rein. “Even with these challenges, our pharmacies are consistently performing ahead of the industry.”

Walgreens is also facing hurdles at the front end of the store. “In reaction to the economy, we invested more than originally planned in promotional and pricing programs in the fourth quarter,” said president Greg Wasson. “While their high value attracted customers, they did not produce the incremental sales we’d hoped for.”

Indeed, Walgreens said front-end margins were “essentially flat,” while “pharmacy margins increased due to greater use of generics.” Overall margins, the company noted, “were negatively impacted by non-retail businesses, including specialty pharmacy, which have lower margins and are becoming a greater part of the total business.”

Walgreens is responding with a sharp focus on cost controls. “Going forward, we plan to moderate our promotional activity while focusing on the value of our convenience and services,” said Wasson. In addition, noted Rein, “We have maintained strong cost control and will continue to evaluate our operations across the company for even more efficiencies.”

To spark sales, the company has also named Kim Feil to the new position of vice president and chief marketing officer, reporting to Wasson. Feil, a 25-year veteran of Sara Lee, Kimberly-Clark and other firms, will lead a new marketing organization charged with responding to the evolving needs of Walgreens customers and pharmacy patients.

“Under Kim’s direction, our marketing folks will enhance the in-store customer experience and create stronger connections to our online offerings and Take Care Clinic services,” said Wasson. “Kim brings a strong consumer research and marketing background to us at a time when deep understanding of customers is critical.”

Walgreens also named George Riedl, executive vice president of marketing, to the additional post of executive vice president of merchandising. Riedl will continue overseeing purchasing and merchandising, marketing services and research, but will also oversee a new customer-centric retailing project. “This initiative will leverage consumer insights and data gathered by Walgreens and our strategic vendors to reorient the store experience around the customer and create merchandising solutions that make our stores easier and more convenient to shop,” said Wasson.

As for fiscal 2008, Wall Street was underwhelmed by Walgreens’ numbers, which came in lower than analysts’ consensus expectations. Because of “worse than expected gross margin and SG&A [sales, general and administrative costs] expense performance,” wrote analyst Deborah Weinswig of Citi Investment Research, “we remain cautious on WAG due to slowing sales top-line growth as a result of the weak macro environment, as well as SG&A pressure due to a lower sales base.

“Additionally,” she warned, “we will continue to monitor WAG’s acquisition strategy as it positions itself in this changing health care landscape.”

Noting that Walgreens’ fourth-quarter performance was “basically in line with expectations,” analyst Mark Miller of William Blair & Company stated, “The largest positive development in the quarter was front-end profitability, as the increased penetration of the higher-margin, private-label business and other margin lifts apparently offset the adverse impact of more aggressive [and somewhat ineffective] promotion activity.”

Miller noted that Walgreens’ management “made cautionary comments regarding the state of the consumer … that cause us to lower our EPS [earnings per share] projections going forward.”

Despite the lower expectations, Miller added, “we are encouraged that the company has made higher-level changes in its approach, including the moderation in capital expenditures, hiring of outside talent for key positions, plans to rationalize the SKU assortment, and a heightened awareness of the need to become a more consumer-centric organization.” It could be a year or more, however, before those changes yield significant financial improvements, he warned.

Standard & Poor’s also sounded a cautionary note. “We expect continued pressure from the adverse economic environment and note that demand was softer than [Walgreens] expected despite having exceeded original promotional and pricing budgets,” warned S&P analyst Joseph Agnese.