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Walgreens confident in face of Brexit and Rite Aid uncertainty

Stefano Pessina
Shaun Curry | AFP | Getty Images
Stefano Pessina

Walgreens Boots Alliance executives say they are confident about the second half of the year, despite the uncertainty raised by last month's Brexit vote, and the ongoing regulatory review of their pending $9.5 billion acquisition of rival Rite Aid.

The deal remains on track to close at the end of the year, Executive Vice Chairman and CEO Stefano Pessina said on the pharmacy chain's earnings conference call.

"Our lawyers are telling us that we don't have any negative signal, and so we are operating on the hypothesis that we will do the deal," he explained. "We are trying to find the right buyers for the pharmacies that for sure we will have to divest."

Pessina estimated that the combined company will have to sell roughly 500 stores in order to gain regulatory approval from the Federal Trade Commission, which is overseeing the antitrust review of the merger.

Investors have at times been uneasy about the deal, says Evercore ISI analyst Ross Muken, after the FTC opposed retailer Staples' acquisition of rival Office Depot, as well as a number of hospital-care mergers in recent months.

"There's nothing that has come up so far that would make us believe that [the Rite Aid deal] is not going to close, but it's been very difficult to predict the FTC for some time," said Muken.

Walgreens is the first major U.S. firm with British exposure to report earnings results since British voters elected to leave the European Union last month. As a result of its 2014 acquisition of the U.K.'s Alliance Boots chain, Britain represents the company's second largest market by sales.

"The situation, it's very volatile at this time. For sure, the period of uncertainty will be quite long, whatever happens," said Pessina, adding that it's too soon to know what impact it will have on the chain. "We have seen in the stores… very good days, very bad. In a few months, probably, we will be able to say something."

That said, Co-Chief Operating Officer Alex Gourlay expressed confidence the chain is well-positioned to weather the Brexit uncertainty, even if it leads to an economic downturn.

"Historically, Boots has been very solid through difficult times, but it tends to overperform the market during recessions or slowdowns because it's got a very strong beauty business and people still buy into beauty even in tough times," he said.

Still, Walgreens international sales were a weak spot in the company's third-quarter earnings report. On the bottom line the firm reported adjusted profits of $1.18 a share, four cents better than the Factset analyst consensus. Revenue of $29.5 billion was below expectations, hurt in part by weaker international sales due to the strong dollar.

In the U.S., the chain's pharmacy sales rose 6 percent during the quarter, driven by growth in Medicare Part D prescription volume, though new federal reimbursement rates weighed on margins.

"Earnings in retail… are solid and somewhat of a relief, given the fact that the new Medicare Part D rates went into effect [Jan. 1] and this quarter reflects the full impact of that incremental volume," wrote Leerink analyst David Larsen in a research note to clients.

Non-prescription retail sales were flat, up just 0.1 percent after two quarters of declines. The company says it is investing more on expanding its Boots No. 7 beauty brand nationally in the U.S., in order to drive more traffic and higher spending in its retail business.

Still, Evercore's Muken sees the potential for greater sales and margin expansion.

"If they're able to get the Rite Aid deal closed… they continue to cut costs – this company's growing earnings in the teens. That's quite attractive in this market," he said.

Walgreens has already raised the capital it needs to fund the completion of the Rite Aid merger. The company was asked on the call what kind of plans it has in the event regulators block the deal.

Pessina, who is known as a dealmaker, replied, "We would have lots of ideas."

Walgreen shares fell as much 3.5 percent, but were recently trading down 2.4 percent at $81.54. Rite Aid shares were recently up nearly 2 percent on the day at $7.44.