Time to Invest in America's Largest Pharmacy?

Walgreen Co. , the largest owner and operator of pharmacies in the United States, announced its third-quarter earnings results on June 24 and its stock reacted by making a move to the downside. It's not often that we see a pullback in this American titan, so let's take a look at the results and other key financials and then compare it to its largest competitor, CVS Caremark , to determine if this decline is our opportunity to buy or if there is an underlying issue that is warning us to stay away.

Source: Walgreen Co.

Walgreen mixes it up in the third quarter
Walgreen released its third-quarter report before the market opened on June 24 and the results were mixed compared to the consensus analyst estimates; here's an overview:

Source: Benzinga

Walgreen's earnings per share increased 7.1% and revenue increased 5.9% year-over-year, driven by an impressive 4.8% comparable-store sales rise; this strong growth in comparable-store sales was helped by an 8.4% increase in prescription sales, which accounted for 64.4% of total sales during the quarter. Walgreen also noted that it now owns an incredible 19% share of the retail prescription market, up 20 basis points from the year-ago quarter.  

Source: Walgreen Co.

Gross profit increased 4.2% to $5.44 billion and operating profit increased 3.5% to $1.03 billion, but the gross margin contracted 40 basis points to 28.1% and the operating margin contracted 10 basis points to 5.3%; these contractions resulted from cost of sales increasing 6.6% and selling, general, and administrative expenses increasing 4.3%. 

For the quarter, Walgreen had roughly $1 billion of free cash flow; the company used this free cash and the $2.11 billion in cash and cash equivalents it had at the beginning of the quarter to retire $742 million in long-term debt, pay $301 million in dividends, and open two new stores; as of the conclusion of the third quarter, the company had $3.75 billion in long-term debt, $2.13 billion in cash and cash equivalents, and 8,683 stores in all 50 of the United States, the District of Columbia, Puerto Rico, Guam, and the U.S. Virgin Islands. 

Source: Walgreen Co.

So were these results good, bad, or so-so?
With all of the results in hand, I think it was a great quarter for Walgreen, regardless of whether or not it met the expectations of analysts, but the stock reacted by falling 1.7% on the day of the release; in the trading days since, the stock has traded erratically, but I believe it represents a great long-term opportunity at current levels. Here are my three top reasons why Walgreen's belongs in your portfolio today:

1. Prescriptions: Sales of prescriptions have shown consistent growth over the last decade and I believe this trend is here to stay; with a now 19% share of this market, Walgreen's is by far the best way to play it.
2. Expansion: Walgreen's currently has more than 8,600 stores, but there are still plenty of untapped markets for it to expand to. I believe the company could easily grow its store count to 10,000 over the long-term.
3. Joint Venture with Alliance Boots: Walgreen's and Alliance Boots entered into a joint venture to form the world's first "pharmacy-led, healthy and wellbeing enterprise" in August of 2013 and it has already positively affected the financials of both companies. The two companies will continue to build on this relationship and I believe it could be one of the main drivers of Walgreen's growth going forward.

A record quarter for the competition
CVS Caremark, the second-largest owner and operator of pharmacies in the United States, released earnings of its own back on May 2 and it too reported mixed results; here's a summary of its first quarter:

Source: Benzinga

Earnings per share increased 22.5% and revenue increased 6.3% compared to the same period a year ago, as comparable-store sales grew 1.4%; these results were driven by a 10.3% increase in revenue from its pharmacy services segment and a 2.7% increase in its retail pharmacy segment. 

Source: Wikimedia Commons

CVS' gross profit increased 6.5% to $5.94 billion and operating profit increased 19.5% to $2.02 billion, as its gross margin expanded 10 basis points to 18.2% and operating margin expanded 70 basis points to 6.2%; cost of sales and operating expenses increased just 6.2% and 0.9%, respectively, which enabled the margin increases. 

Lastly, CVS generated $1.8 billion in free cash flow during the quarter which allowed it to repurchase $801 million worth of its common stock, pay $325 million in dividends, open 15 net new retail drugstores, and reaffirm its full-year outlook, among other things. The company now operates 7,829 locations in 47 states, the District of Columbia, Puerto Rico, and Brazil.

All in all, it was a healthy quarter for the No. 2 company in the industry. I believe CVS could provide substantial returns over the next several years, so investors who are not sold on Walgreen's potential should take a deeper look at it.

The Foolish bottom line
Walgreen Co. is one of the most powerful brands in the United States and its now 19% share of the retail prescription market proves that it is a growing force to be reckoned with. The company's stock took a slight hit after mixed third-quarter earnings, but I believe the long-term potential of Walgreen far outweighs any short-term negativity so Foolish investors should give it a second look.