Muge Tian

1

• Muge Tian
• Yanlei Xu
• Ben Hier
• Mohamed Ibrahim
• November 29, 2007

2
Agenda

• Company Overview
• Macroeconomic Outlook
• Industry Competitors
• Recent Developments
• Portfolio Position
• DCF Valuation
• Comparable Multiple Valuation
• Recommendation

3
Company Overview

• Incorporated as an Illinois corporation in 1909,
  as a successor to a business founded in 1901
• Nations largest retail drugstore chain (based on
  sales)
• 33rd year of consecutive sales and earnings
  growth
• Sales are expected to continue to grow
• Aging population
• Introduction of lower priced generics
• Development of innovative drugs
• Convenience positioning 139.1 million people
  live within 2 miles
• Traffic 5 million shoppers in one store location
  daily
• As of Aug 31,2007, 5997 stores located in 48
  states and Puerto Rico.

4
Walgreens Business
Prescription Drugs
Candy
Non-Prescription Drugs
Photofinishing
Walgreens
Greeting Cards
Beauty Care
Personal Care
Seasonal Items
Household Items
Convenience Foods
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Product Class
6

20102011
Top Five States
Florida
Texas
Illinois
California
Arizona
736
587
528
476
234
US Demography Over 50 of baby boomers in
Florida, Texas, Illinois, California, New York,
Pennsylvania, Ohio, Michigan, New Jersey
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Growth Strategy

• Store openings
• Locating new stores, relocating/closing exiting
  stores, site selection (convenience positioning)
• 2007, opened or acquired 563 stores.
• Continue growth, anticipating more than 7000
  locations in 2010.

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Acquisitions

• In 2006
• Merger with Happy Harrys pharmacy chain
• Purchase of
• Medmark Inc. ( Specialty pharmacy )
• Schrafts ( Specialty pharmacy)
• Canadian Valley medical ( Home care services)
• Home pharmacy of California (home infusion
  service)
• Controlling interest in Senior Med
• In 2007
• Option Care Inc. (specialty pharmacy home
  infusion service)
• Take care health systems (convenient care clinic
  operator)
• Remaining interests in Senior Med.

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Walgreens
Risk Factors
Competition
Regulations
Product Liability
Economic Condition
Reduction Reimbursement
Store Location
Pharmacy Personnel
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Macroeconomic Conditions

• Oil Price

• Consumer Confidence

Source Wall Street Journal The Conference Board,
The Consumer Confidence Press Release
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Industry Overview

• Industry Drug retail
• CVS/Caremark Corp. (CVS) and Rite Aid Corp. (RAD)
• Business segments prescription and
  non-prescription drugs, and general merchandise

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Industry

• Sources and availability of raw materials
• numerous domestic and foreign suppliers
• Seasonal variation
• timing and severity of cold/flu season, holidays
• Dependence upon limited number of customers
• no customers counts for 10 or more of
  consolidated sales
• Competition
• chain and independent drug stores, mail order
  prescription providers, grocery stores,
  convenient stores, mass merchants, and dollar
  stores
• service, convenience, variety and price

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5-Year Industry
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1-Year Stock Performance
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Porters Five Forces Retail Drug Industry

• Rivalry High
• Existing drug stores
• Direct mail pharmacy benefit managers
• Grocery stores big box retailers
• Threat of Substitutes Low
• Few alternative choices for products sold at
  Walgreens/Drug Retailers
• Bargaining Power of Buyers Moderate
• Insurance companies
• Walgreens receives premium prices for front end
  convenience items
• Bargaining Power of Suppliers High
• Drug companies have price control
• Barriers to Entry Moderate
• High initial capital expenditures supplier
  relationship required

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Generic Pipeline

• Lipitor (1) and Prevacid (3) are among the top
  selling drugs in the U.S.
• Generic drug pipeline will not be as robust as
  2006 (14B) 2007 (14B)
• Opportunity for higher margin generics despite
  declining reimbursement rates

Source Forbes.com
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Path From Branded to Generic

• Stage III
• 6/2/2007 - Future
• Generic Exclusivity Ends
• Sold at 52 of Branded Price
• Insurance Companies Reduce Reimbursement

• Stage II
• 1/2/2007 - 6/2/2007
• First Generic Version Available
• 6 Month Exclusivity
• Sold at 94 of Branded Price
• Insurance Companies Offer High Reimbursement Rates

• Stage I
• 1/1/1995 - 1/1/2007 (Est. 12 Yrs)
• Full Price Branded Drug Available
• Low Margin Product

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Recent Developments

• Wal-Mart Threat
• In June 07, Wal-Mart announced a 4 prescription
  program
• The effect didnt last for long time (less than 6
  weeks).
• This is not a threat because
• The drugs covered by this program are not widely
  demanded by patients.
• For Walgreens prescription drug represents 65 of
  sales , of which 94.8 Third party sales.
• Third party
• 1-Medicare senior above 65 years
• 2-Medicaid low income people
• 3-Private insurance
• Wal-Mart targets those who are not covered by any
  insurance and that represents 5 of the USA
  population.

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Recent Developments Cont.

• On Oct 1st 2007 , Walgreen announced a decline in
  Q4 earnings by 3.8.
• Although the annual data showed an increase in
  earnings by 16.6, sales increased by 13.3.
• Walgreen lost 15 (7.04) on that day.
• Walgreen is held by many institutional investors,
  so when Walgreen missed their expectations,
  shares sold off abruptly

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Recent Developments Cont.

• The management attributed this decline
• Lower generic drug reimbursement
• Higher SGA, higher salary, store expenses, higher
  advertising cost and some administrative costs
  related to acquisitions
• The absence of new blockbuster generic drugs to
  enter the market during Q4.
• The expansion in third party selling (Medicare
  program) that has lower margins.

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The Zocor Story

• Cholesterol drug
• Huge seller in 2005 more than 4 billion
• Generic became available June 2006
• Sales increased as insurers force people to
  switch to the generic, even from other drugs like
  the Lipitor and Crestor.
• More generics start to appear, insurers force
  drug makers to lower the price, insurers pay
  lower reimbursements.
• Even when sales of Simvastatin (generic Zocor)
  tripled, yet gross profit was flat.
• At same time SGA costs increased by 15, extra
  was needed staff to fill the increase in the size
  of business

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Patent Expiration Schedule
23
RCMP Position

• Purchased 1000 shares of WAG on October 6th, 1999
  for 25.00/share
• On September 20th, 2006, sold 500 shares _at_
  49.94/share for a realized gain of 12,470
• Currently own 500 shares of WAG, trading at
  38.31 as of Nov 28, 2007 for an unrealized gain
  of 6,655 or 53.24.

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Role in Portfolio
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Correlation Matrix
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Lease Obligations

• 19.1 of stores are owned while 80.9 are leased
• The present value of lease obligations quasi
  debt is 15.794 billion
• We should take the risk from these operating
  leases into consideration

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DCF Assumptions

• Store openings and Capex
• Increase trend SGA
• Increase gross profit margin
• Sales will grow in 08 due to patent expiration
• Wacc Calculation
• Equity 93 Debt 7
• Beta 0.55
• Rf 4.05 (10 yr treasury note)
• Ke 7.35
• Kd 5.36
• WACC 7.07
• Long term growth rate 3
• DCF Value 41.66

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Comparable Analysis
Source Onesource
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Public Comparables Analysis
Closing Price 38.31 P/E (TTM) 22.94
2.03 46.57 Forward P/E 16.83 2.03
34.16 Average 40.37
Source Onesource Google Finance
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Recommendation

• Hold 500 Shares
• DCF valuation near current stock price
• Generic drug outlook not as robust as 2006-07
• Low correlation to existing portfolio holdings
• Macroeconomic outlook