Aggressive Cost Reduction Protects Margins For Walgreens

The 3QFY16 financial results indicate that Walgreens Boots Alliance Inc (NASDAQ: WBA) has executed well against synergy and cost reduction targets, Barclays’ Eric Percher said in a report. He maintained an Equal Weight rating on the company, while raising the price target from $76 to $79.

GM Disappointment

Although Walgreens had significant synergy benefits and most of the cost reduction focused on the Retail US segment, margins missed expectations. Gross margins declined by 52bps y/y in 3QFY16, compared to Barclays’ estimate of a 6bps decline.

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This suggests that reimbursement pressures were more intense than was expected, sourcing benefits less beneficial than anticipated and the decline in Gx inflation had not contributed as much as was expected, analyst Eric Percher noted.

Some of the GM weakness was offset by a 54 bps y/y decline in SG&A, due to aggressive cost reduction by the company.

Role Of Cost Reduction

Walgreens appears to be on track to achieving its cost reduction target of $1.0bn by FY16 and $1.5bn by FY17.

Percher commented, however, that while cost reduction “will clearly play a role in supplementing core growth in FY17,” for the company to achieve double-digit earnings growth in the face of declining reimbursement would require it to move from cost reduction to “transforming WBA's beauty offering, offsetting high occupancy costs through volume additions, and capturing RAD synergies - all of which we expect will be considerably more difficult than cutting cost.”