WALGREEN CO.WALGREEN CO.Matt ByfordMatt Byford

Brandon HoneyBrandon HoneyShivam KhannaShivam Khanna

Joe VaccaroJoe Vaccaro

October 28, 2008October 28, 2008

AgendaAgenda

►Company Overview Company Overview ►Macroeconomic OverviewMacroeconomic Overview► Industry OverviewIndustry Overview►Recent DevelopmentsRecent Developments►Forecasting/ExpectationsForecasting/Expectations►Valuation of WalgreensValuation of Walgreens►RecommendationRecommendation

Company OverviewCompany Overview

►Founded in 1901 by Charles WalgreenFounded in 1901 by Charles Walgreen 11stst store was in Chicago store was in Chicago

►226,000 employees as of 8/31/2007226,000 employees as of 8/31/2007►Goal is to have 7,000 stores open by Goal is to have 7,000 stores open by

20092009

Company OverviewCompany Overview

► Walgreen company operates retail drug store chains that Walgreen company operates retail drug store chains that are engaged in the retail sale of prescription drugs, non-are engaged in the retail sale of prescription drugs, non-prescription drugs, and general merchandise. prescription drugs, and general merchandise.

► In 2008, it opened 561 net new stores for a total of 6443 In 2008, it opened 561 net new stores for a total of 6443 Walgreens in 49 states, District of Columbia, and in Puerto Walgreens in 49 states, District of Columbia, and in Puerto Rico.Rico.

► It is the fastest growing retailer in the US, and is the 2It is the fastest growing retailer in the US, and is the 2ndnd largest drugstore chain behind CVS.largest drugstore chain behind CVS.

► Ranked 44Ranked 44thth on the Fortune 500 list of the largest US-based on the Fortune 500 list of the largest US-based companies.companies.

► On the list of Fortune’s magazine’s Most Admired On the list of Fortune’s magazine’s Most Admired Companies in America for the last 14 consecutive years.Companies in America for the last 14 consecutive years.

Company OverviewCompany Overview

► A.G. McNallyA.G. McNally Chairman of the Board since 2008Chairman of the Board since 2008 Chief Executive Officer since 2008Chief Executive Officer since 2008 Board member sine 1999Board member sine 1999

► Gregory WassonGregory Wasson President and Chief Operating Officer since 2007President and Chief Operating Officer since 2007

► Jeff Rein retired in October 2008Jeff Rein retired in October 2008 Chairman and Chief Executive officer since 2003Chairman and Chief Executive officer since 2003

► William RudolphsenWilliam Rudolphsen Senior Vice President and Chief Financial Officer Senior Vice President and Chief Financial Officer

since 2004, new role as Chief Risk Officersince 2004, new role as Chief Risk Officer► Has been with Walgreens since 1977Has been with Walgreens since 1977

Decline in Consumer Confidence

Macroeconomic Overview

Consumer Confidence Index (CCI)

0

20

40

60

80

100

120

CCI hit all time low in June 2008 (51)

Macroeconomic OverviewMacroeconomic Overview

► Oil continues to be volatile, but lower prices will have positive impact on Oil continues to be volatile, but lower prices will have positive impact on economyeconomy

► Cost to do business will be lowerCost to do business will be lower

StrategyStrategy

► Organic store growthOrganic store growth► Relocate, remodelRelocate, remodel► Densely-populated areas like Southern California and NortheastDensely-populated areas like Southern California and Northeast

► Invest heavily in high-tech store and distribution systems Invest heavily in high-tech store and distribution systems which drive service up and costs down which drive service up and costs down

► Acquisitions where there are synergiesAcquisitions where there are synergies► Healthcare offerings beyond that of a traditional pharmacyHealthcare offerings beyond that of a traditional pharmacy

Offer an online drugstore web site totally integrated with retail Offer an online drugstore web site totally integrated with retail storesstores

Take Care Healthcare SystemsTake Care Healthcare Systems► Increase market share in front-end of storesIncrease market share in front-end of stores► Must continue to find ways to leverage the benefits of scale Must continue to find ways to leverage the benefits of scale

without losing the ability to react quickly to changes in without losing the ability to react quickly to changes in customer needscustomer needs

StrategyStrategy

►GrowthGrowth Walgreens is currently increasing their net Walgreens is currently increasing their net

stores operated by approximately 1 store stores operated by approximately 1 store every 16 hoursevery 16 hours

The company, which currently operates The company, which currently operates 6,443 stores, plans to operate at least 6,443 stores, plans to operate at least 7,000 stores by 20097,000 stores by 2009

►See room for organic growth to 13,000 storesSee room for organic growth to 13,000 stores

InnovationsInnovations

► Introduced freestanding stores in early Introduced freestanding stores in early 1990s with drive thru pharmacies1990s with drive thru pharmacies

►Today, more than 80% of Walgreen Co.’s Today, more than 80% of Walgreen Co.’s stores have drive thru pharmaciesstores have drive thru pharmacies

► Nation-wide 1 hour photo serviceNation-wide 1 hour photo service►Available at more than 98% of storesAvailable at more than 98% of stores

► Touch tone prescription refillsTouch tone prescription refills

►50% of people live within 2 miles of a 50% of people live within 2 miles of a WalgreensWalgreens

Drug Store IndustryDrug Store Industry

► Highly Competitive IndustryHighly Competitive Industry Competition with other drugstore chains, independent Competition with other drugstore chains, independent

drugstores, mail order prescription providers, internet drugstores, mail order prescription providers, internet pharmaciespharmacies

Other competitors include various grocery stores, mass Other competitors include various grocery stores, mass merchants, and dollar storesmerchants, and dollar stores

► Main competitors:Main competitors: CVS Corp. (CVS)CVS Corp. (CVS) Rite Aid Corp. (RAD)Rite Aid Corp. (RAD) Wal-Mart (WMT)Wal-Mart (WMT)

► Pharmaceutical more than grocery departmentPharmaceutical more than grocery department► Now offers a $4 generic prescription planNow offers a $4 generic prescription plan

Drugstore.comDrugstore.com

RCMP PositionRCMP Position

► Own 500 shares in WalgreensOwn 500 shares in Walgreens► Purchased at $25/share on 10/06/1999Purchased at $25/share on 10/06/1999► Sold 500 shares at $49.94/share on Sold 500 shares at $49.94/share on

9/14/20069/14/2006► Cost Basis is $12,500Cost Basis is $12,500► Stock is now trading at $21.40/shareStock is now trading at $21.40/share

►Valued at $10,700Valued at $10,700

► Represents 2.4% of portfolio market valueRepresents 2.4% of portfolio market value► Unrealized Loss of $1,800 or 14.4%Unrealized Loss of $1,800 or 14.4%

Shareholder BaseShareholder Base

►67% of shares owned by institutional 67% of shares owned by institutional investorsinvestors

►125,000 shares sold by insiders in last 125,000 shares sold by insiders in last 6 months6 months

CorrelationCorrelation

BusinessBusiness

Drugstores

Prescription drugs

NonprescriptionDrugs

General merchandise

Take careHealthclinics

Home infusionTherapy provider

Specialty pharmacy

Product classProduct class

► Prescription sales continue to become a Prescription sales continue to become a larger portion of the company’s business.larger portion of the company’s business. Aging populationAging population Introduction of lower priced generics (Medicare D)Introduction of lower priced generics (Medicare D) R&D of innovative drugs R&D of innovative drugs

   20082008 20072007 20062006 20052005

PrescriptionPrescription 66%66% 65%65% 64%64% 64%64%

Non-prescriptionNon-prescription 10%10% 10%10% 11%11% 11%11%

General MerchandiseGeneral Merchandise 24%24% 25%25% 25%25% 25%25%

Walgreen OutlookWalgreen Outlook► AdvantagesAdvantages::

Good reputation / qualityGood reputation / quality Convenience of locations: High market shareConvenience of locations: High market share Economies of scaleEconomies of scale Aging populationAging population

► Risk factors:Risk factors: Peaking generic drug cycle: Peaking generic drug cycle: Store saturation/cannibalizationStore saturation/cannibalization Competition from CVS/Caremark, Wal-MartCompetition from CVS/Caremark, Wal-Mart Diverging from original growth strategyDiverging from original growth strategy

Porters Five Forces: Porters Five Forces: Retail Drug IndustryRetail Drug Industry

► Rivalry: HighRivalry: High Competitive IndustryCompetitive Industry Direct mail pharmacy benefit managersDirect mail pharmacy benefit managers Grocery stores & big box retailersGrocery stores & big box retailers

► Threat of Substitutes: LowThreat of Substitutes: Low Few alternative choices for products sold at Walgreens/Drug Retailers Few alternative choices for products sold at Walgreens/Drug Retailers

► Bargaining Power of Buyers: ModerateBargaining Power of Buyers: Moderate Insurance companiesInsurance companies Walgreens receives premium prices for front end convenience itemsWalgreens receives premium prices for front end convenience items

► Bargaining Power of Suppliers: ModerateBargaining Power of Suppliers: Moderate Watch government regulations / upcoming electionWatch government regulations / upcoming election

► Barriers to Entry: ModerateBarriers to Entry: Moderate High initial capital expenditures & supplier relationship requiredHigh initial capital expenditures & supplier relationship required

ComparablesComparablesWAGWAG CVSCVS RADRAD WMTWMT IndustryIndustry

Market Cap:Market Cap: 21.18B21.18B 35.05B35.05B 379.52M379.52M 195.40B195.40B 2.56B2.56B

Qtrly Rev Qtrly Rev Growth:Growth: 8.80%8.80% 2.10%2.10% -1.10%-1.10% 10.40%10.40% 13.40%13.40%

Revenue:Revenue: 59.03B59.03B 84.90B84.90B 26.44B26.44B 397.38B397.38B 6.20B6.20B

Gross Margin:Gross Margin: 28.19%28.19% 20.39%20.39% 27.31%27.31% 24.47%24.47% 27.31%27.31%

EBITDA:EBITDA: 4.28B4.28B 6.65B6.65B 708.66M708.66M 29.79B29.79B 505.83M505.83M

Oper Margins:Oper Margins: 5.83%5.83% 6.43%6.43% 0.53%0.53% 5.83%5.83% 4.87%4.87%

Net Income:Net Income: 2.16B2.16B 3.06B3.06B -1.44B-1.44B 13.39B13.39B N/AN/A

EPS:EPS: 2.1662.166 2.0362.036 -1.78-1.78 3.3613.361 0.740.74

P/E:P/E: 9.889.88 11.9911.99 N/AN/A 14.7814.78 13.6413.64

PEG:PEG: 0.760.76 0.790.79 N/AN/A 1.31.3 0.860.86

P/S:P/S: 0.380.38 0.470.47 0.020.02 0.510.51 0.410.41

Source: Yahoo Finance

1 Yr. Stock Performance1 Yr. Stock Performance

Source: Yahoo Finance

5 Yr. Stock Performance5 Yr. Stock Performance

Source: Yahoo Finance

Longs Bid WithdrawalLongs Bid Withdrawal

►Competitive action vs. Failed actionCompetitive action vs. Failed action Caused CVS to overvalue LongsCaused CVS to overvalue Longs CVS must pay $71.50 per shareCVS must pay $71.50 per share Most likely has to access debt Most likely has to access debt

►Challenging debt marketChallenging debt market►CVS must pay a penalty if it cannot access CVS must pay a penalty if it cannot access

financingfinancing

Longs Bid WithdrawalLongs Bid Withdrawal

►Longs is exposed to the poor condition of Longs is exposed to the poor condition of the CA marketthe CA market

►Longs would have few synergies with Longs would have few synergies with WAGWAG

►WAG did not want to risk its credit ratingWAG did not want to risk its credit rating Senior unsecured debt was downgraded Senior unsecured debt was downgraded

anyway from AAA to AAanyway from AAA to AA►EBIT coverage ratio fell because of increase in LT EBIT coverage ratio fell because of increase in LT

debtdebt►Uncertainty of strategic directionUncertainty of strategic direction►CEO Jeff Rein retired CEO Jeff Rein retired

ExpectationsExpectations

► Prescription sales will growPrescription sales will grow► Specialty Pharmacy sales will become a Specialty Pharmacy sales will become a

greater part of the businessgreater part of the business► 70007000thth store will open FY 2009 store will open FY 2009► Organic store growth will begin slowing in Organic store growth will begin slowing in

20112011 Increases flexibilityIncreases flexibility Slower sales growthSlower sales growth

► Promotional activity will be moderatedPromotional activity will be moderated► People will return to their doctors as the People will return to their doctors as the

economy recoverseconomy recovers

Generic Drugs ExpectationsGeneric Drugs Expectations

►Greater use of generic drugs as baby Greater use of generic drugs as baby boomers retire and receive a fixed boomers retire and receive a fixed incomeincome

►A significant amount of brand name drugs A significant amount of brand name drugs are expected to come off of patent are expected to come off of patent between 2009-2011between 2009-2011 Currently, WAG is in a valleyCurrently, WAG is in a valley

►There were few brand name drugs coming off of There were few brand name drugs coming off of patent in 2008patent in 2008

Expect a peak within the next 3 yearsExpect a peak within the next 3 years

ExpectationsExpectations

►A new CEO is expected to lead A new CEO is expected to lead WalgreensWalgreens Upside potentialUpside potential

►Possible political effects with more Possible political effects with more affordable health care coming from affordable health care coming from different plansdifferent plans

Valuation – DCF AnalysisValuation – DCF Analysis

►Cost of equity = 7.6%Cost of equity = 7.6%►Cost of debt = 5.36%Cost of debt = 5.36%►Wacc = 7.35%Wacc = 7.35%►Long term growth = 3%Long term growth = 3%►Stock Price = 23.55Stock Price = 23.55

Comparable’s dataComparable’s data

►Strong profitability margins; expected Strong profitability margins; expected decline over 5 yearsdecline over 5 years

►Strong Return on Equity, Return on Strong Return on Equity, Return on Asset numbers; expected declineAsset numbers; expected decline

► Implied growth through PEG ratio Implied growth through PEG ratio lower than industry average lower than industry average

►P/E ratio is lower than market and P/E ratio is lower than market and industry averageindustry average

EVA AnalysisEVA Analysis

►Strong Return on Average Invested Strong Return on Average Invested Capital, expected decline going Capital, expected decline going forwardforward

RecommendationRecommendation

►Hold the stock at this price. People Hold the stock at this price. People have over-reacted and this has pushed have over-reacted and this has pushed the stock price down. Company is well the stock price down. Company is well positioned as compared to it’s peerspositioned as compared to it’s peers

►New CEO could put the company back New CEO could put the company back on track.on track.