Walgreen Company (WAG), Rite Aid Corporation (RAD): Make No Mistake, the Best Days Are Yet to Come in This Space

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After a 53% gain over the last year, shares of Walgreen Company (NYSE:WAG) are seeing a pullback after earnings. The stock, currently trading lower by almost 8%, follows Rite Aid Corporation (NYSE:RAD)’s 11.5% loss during the last five sessions. However, make no mistake about it, this is a pullback, not the start of a large trend lower, and these stocks are still a buy.

Walgreen Company (NYSE:WAG)

Lousy Stock Performance Does Not Indicate Bad Quarters

I always tell people, read the quarterly report first, listen to the conference call second, and by that time the stock will have found a steady trading range. In the meantime, make an assessment of the quarter based on the information in the conference call and in the quarterly report, not based on the stock’s performance. With that said, here is how I assess the quarterly reports of both Walgreen and Rite Aid Corporation (NYSE:RAD).

Walgreens missed quarterly expectations and saw a horrible decline in store traffic of 3.9% year-over-year. However, the company saw great progress in other areas, including continued earnings/margin expansion.

On June 20, we saw that Rite Aid Corporation (NYSE:RAD) posted a 2.7% decline in total revenue year-over-year yet increased net income from a loss of $28.1 million to a profit of $89.7 million. Much like Walgreen Company (NYSE:WAG), the company saw a 0.4% rise in comparable front store sales.

Walgreen Company (NYSE:WAG) saw a 3.2% rise in year-over-year revenue, but saw its adjusted earnings rise 29.3% over the prior year. Therefore, we are seeing exceptional margin improvements, including at CVS, and this trend is not expected to change.

The common trend among pharmacies is to see greater prescription volume, slower revenue growth, and massive net income growth. Walgreen Company (NYSE:WAG)'s pharmacy business saw a 3.4% rise in year-over-year revenue but saw volume increase 8.7%, which further validates this trend.

The Importance of Generics & its Future Relevance

These companies have been able to record higher profits because of new generic introductions. In the pharmacy business, generics return higher margins to the pharmacy, as generic drug companies pay pharmacies a higher premium to switch from higher priced brand name drugs.

When you consider that Walgreen Company (NYSE:WAG) traded at just 0.40 times sales and Rite Aid traded at 0.05 times sales last year, it is clear to see why higher margins would produce large gains in the sector (110% gain for Rite Aid Corporation (NYSE:RAD) over the last year), as revenue is deeply discounted in this space.

Aside from the grocery business, the pharmaceutical industry has always had the lowest margins in the market. Today, the trend is changing, and pharmacies are seeing great growth in margins, which is evident based on the earnings of both Walgreen Company (NYSE:WAG) and Rite Aid Corporation (NYSE:RAD).

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