A Healthy Outlook In an Aging America

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The New York Sun

One doesn’t have to be a brain surgeon to recognize the explosion in the number of aging Americans. Signs are all around: baby boomers are turning 60; Andre Agassi is retiring; the number of people on Social Security hit a record 48 million at the end of 2005; more folks than ever are reaching 100; pharmaceuticals are one of the fastestgrowing areas in TV advertising, and life-preserving medical breakthroughs are sharply on the rise.

To Morgan Stanley, it means the investment theme of a graying America is finally coming of age.

One of Morgan Stanley’s favorite beneficiaries is the country’s largest drug store chain, Walgreens ($45.24), which boasts 5,250 stores in 45 states and posted 2005 sales of $42.2 billion. Its stock, though, has hardly been a world beater, having lagged the market the past year and falling about 13% since March because of a penny-a-share shortfall in Wall Street’s fiscal second quarter earnings estimate.

That’s yesterday’s news. In the near future, if Morgan Stanley analyst Mark Wiltamuth knows what he’s talking about, Walgreen’s weak shares could acquire muscles like Samson and post sizable gains.

Mr. Wiltamuth says he believes the 13% decline in the stock has created a buying opportunity. He’s urging clients to overweight Walgreens in their portfolios, and has established a 12-month price target of $54, nearly a 20% gain from current levels. What’s more, he thinks the stock in two years has a shot at ballooning to $80, a 77% increase, if it can regain its price/earnings multiple of 30.At present, it trades at roughly 26 times his calendar 2007 earnings estimate of $2.09 a share.

Walgreens, which operates on an August 31 fiscal year, is pegged by consensus estimates to earn $1.70 a share this year, $1.98 next year, and $2.26 in fiscal 2008. Last year’s net was $1.53.

Mr. Wiltamuth hastens to note that the stock has had a lot of headwinds, with investors nervous regarding the transition into Medicare Part D in the first half of 2006, Medicaid reimbursement rate cuts in 2007, the current trough of new generics, a weak flu season, concerns over the second quarter earnings miss, and soft pharmacy comparisons.

However, with the Medicare transition showing signs of having been digested, the flu season now passed, and second-half positives likely to come from a new wave of high-margin drugs kicking off this month and rising prescription volumes from Medicare Part D patients, he says the shares should stage a recovery over the next six months, with the new generics the primary driver.

Mr. Wiltamuth figures the new wave of generic drugs set to begin this month should last until at least 2010. He estimates generics carry 50% to 90% gross margins for drug retailers, while branded drugs average roughly 15%. Even factoring in lower prices for generics, they still provide up to a 50% lift in gross margin dollars for drug retailers, according to the analyst’s estimates.

He also says the fiscal fourth quarter earnings report to be issued in September could be an approaching catalyst. Mr. Wiltamuth notes that Walgreens’ gross margins have historically tracked closely with the new generics in the marketplace. So if his generic indicator is correct, he says, margins for Walgreens should again rise in the fourth quarter as the number of new generics ramps up through the end of the year. Hence, he views the fourth quarter as a spur for the stock.

Sounds good, but a word of caution: Areas of giant growth, such as drugs, invariably attract giant competition, leading to dwarf-like profits. Nonetheless, Walgreens is a Morgan Stanley prescription for market success.


TECH DEAL? Speculation is rife in technology circles that a deal could be brewing involving the possible acquisition of Mercury Interactive Corp. ($35.60), a $500 million a year manufacturer of software testing products, by computer products biggie Hewlett-Packard ($32.51). The legitimacy of such speculation is unclear, but it is understood that some active buying of Mercury’s shares has occurred on the possibility of such a transaction. The companies declined comment.

The New York Sun

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