Walgreen Co.(WAG)

Presented April 19, 2007

Investment Managers

Jessica Boghosianjboghos2@uiuc.edu

Shengdong Zhuszhu4@uiuc.edu

Company Overview

Incorporated in 1909, headquartered in Deerfield, Illinois. Nation’s largest drugstore based on sales Engaged in the retail sale of prescription and non-

prescription drugs and general merchandise including: beauty care, personal care, household items, candy, photofinishing, greeting cards, seasonal items, and convenience foods.

Recorded its 32nd year of consecutive earnings and sales growth.

During the year, Walgreen Co. had a net increase of 476 stores, totaling to 5,461 stores located in 47 states and Puerto Rico.

Company Overview

Success is dependent upon continuously opening new Walgreens stores.

Walgreen Co. plans to operate more than 7,000 stores by 2010.

Walgreen Co. is in the business of strategically locating new stores as well as relocating/closing existing stores.

New Walgreens Co. Stores

Fiscal Year # of New Stores

2000 462

2001 474

2002 471

2003 430

2004 436

2005 435

2006 570

Over the past 7 years, Walgreen Co. has opened on average 1.28 stores/day.

National Store Distribution

Walgreen Co. has made it a point to open the most stores in the states that are the popular locations for aging baby boomers to retire.

Image: Walgreen Co. Annual Report 2006

Product Class Attribution to Sales

Fiscal Year 2006

Fiscal Year 2005

Fiscal year 2004

Prescription Drugs 64% 64% 63%

Non-Prescription

Drugs11% 11% 12%

General Merchandise 25% 25% 25%

Pharmacy Sales

Pharmacy sales continue to become a larger portion of Walgreens’ business.

Walgreens filled 529 million prescriptions in 2006, totaling to an increase of 8.1% from the 2005 fiscal year.

Sales trends are expected to continue to grow for the following reasons: Aging population Introduction of lower priced generics Continued development of innovative drugs

Medicare Part D

Medicare Part D is a government initiated program to subsidize the costs of prescription drugs to individuals covered by Medicare. Part D was implemented in January of 2006. Walgreens has obtained a larger share of

senior citizen patients due to this program.• 35% of the prescriptions filled under this program

in the first eight months were new customers to Walgreens.

New Developments Dial-a-Pharmacist

Available in 14 languages, this system allows customers to discover where there is a Walgreens pharmacist that speaks his or her language.

Solar Power Usage 100 stores utilize solar energy, making Walgreens

the largest retail user of this source of energy. Highway Signs

A new federal law allows signs to be placed on highways informing drivers of the location of 24 hour pharmacies. Several have already been planted with many more to come.

Source: Walgreen Co. Annual Meeting, January 2006

Corporate Risk Walgreen Co. faces intense competition

with local, regional, and national companies, many of which are infiltrating Walgreens’ existing markets. Extreme competition can have an adverse

affect on prices. Third-party payors of prescription drugs are

attempting to reduce costs and pharmacy reimbursement rates. On February 8th, 2006, President Bush signed

the Deficit Reduction Act of 2005• This Act will ultimately reduce Medicaid

reimbursement rates to retail pharmacies.• Further reduction in these rates are foreseeable.

RCMP Position

Originally owned 1000 shares of WAG, purchases on October 6th, 1999 for $25.00/share.

On September 20th, 2006, 500 shares were sold @ $49.94/share for a realized gain of $12,470.

Currently own 500 shares of WAG, trading at $45.96 as of April 19, 2007 for an unrealized gain of $10,480 or 83.84%.

Role in Portfolio

AEE 6%

AEO 19%

CPRT 9%

FR 7%

FR 7%

JKHY 3%

JPM 14%

KMB 6%

MS 9%

MVSN 1%

SRCL 5%

SRZ 7%

WAG 7%

Walgreen Co. currently comprises 7% of our portfolio.

Correlation Matrix

AEE AEO CPRT FR JKHY JPM KMB MVSN MS SRCL SRZ WAG PortfolioAEE 1.00

AEO -0.08 1.00

CPRT 0.35 0.21 1.00

FR 0.49 -0.02 0.36 1.00

JKHY 0.17 0.40 0.38 0.21 1.00

JPM 0.32 0.47 0.45 0.15 0.55 1.00

KMB 0.30 0.08 0.47 0.14 0.31 0.22 1.00

MVSN 0.21 0.44 0.33 0.20 0.57 0.51 0.06 1.00

MS 0.17 0.50 0.39 0.11 0.46 0.68 0.15 0.57 1.00

SRCL -0.25 0.13 -0.08 -0.03 0.09 0.04 -0.07 -0.11 0.06 1.00

SRZ 0.14 0.21 0.43 0.20 0.40 0.40 0.01 0.50 0.48 0.07 1.00

WAG 0.07 0.09 0.11 -0.18 0.02 0.16 0.26 -0.07 0.18 0.07 -0.17 1.00

Portfolio 0.33 0.63 0.66 0.34 0.74 0.78 0.35 0.76 0.76 0.11 0.62 0.15 1.00

5-Year Growth vs. S&P 500

Competitors

WhoCVS/Caremark Corp. (CVS)Rite Aid Corp. (RAD)

WhyIndustry SpecificBusiness Segment Specific

(prescription and non-prescription drugs and general merchandise)

Out-performing Its Competitors

Prescription Volume

WALGREEN CO. 263/day

Chain Drugstores 180/day

Mass Retailers 143/day

Grocery 131/day

Independents 100/day

Source: Walgreen Co. Annual Meeting, January 2006

Out-performing Its Competitors

Earnings per square foot

WALGREEN CO. $46

Chain Drugstores <$23

Grocery $12

Source: Walgreen Co. Annual Meeting, January 2006

1-Year Comparables

5-Year Comparables

Comparable Analysis

WAG CVS RAD IndustryQtrly Rev Growth (yoy): 14.60% 24.00% -4.40% 12.30%Gross Margin (ttm): 28.08% 27.25% 26.94% 25.26%EBITDA (ttm): 3.77B 3.24B 615.95M 1.70BOper Margins (ttm): 5.97% 5.57% 1.97% 3.79%EPS (ttm): 1.938 1.6 -0.009 1.6P/E (ttm): 23.72 21.61 3.44 26.95

P/S (ttm): 0.9 0.66 0.2 0.66ROA 11.82% 8.76% 3.53%

AssumptionsOrganic growth continues to be the primary

growth vehicleFuture growth was estimated assuming to be

in line with increasing medical costs and increasing store numbers.

We assume that future growth will continue at a 13% annual rate but will gradually decrease to 9% over the next five years and then remain at a 3% annual growth rate thereafter

Discounted Cash Flow Analysis

∆

FY 2007 forecasted FY 2009 forecasted FY 2010 forecasted

Net sales: 53,164.21 64,610.11 70,276.59

Less: Operating costs (50,160.43) (61,088.86) (66,516.79)

Taxes paid (1,158.91) (1,414.90) (1,561.02)

Net investment (416.81) (199.87) (73.89)

? Working capital 881.04 1,052.47 1,338.22

= Free Cash Flow 1,428.06 1,906.49 2,124.88

Discounted Cash Flow Analysis

Since Walgreen Co. is 100% equity financed, WACC=ke.

Beta: Regression 0.1 vs. Bloomberg .66 Average = .4

rf= 4.77%

β= 0.4rm= 11.00%

ke= 7.26%

Discounted Cash Flow Analysis

Total enterprisevalue over 42,079.06 Sharesoutstanding 1,025.40

+ 10% 45.14 =Price Per Share 41.04

- 10% 36.93

Year 1 2 3 4 5FY 2007 forecastedFY 2008 forecastedFY 2009 forecastedFY 2010 forecasted Terminal Value

Free cash flow 1,428.06 1,665.55 1,906.49 2,124.88 Terminal Value 51330.50475PV of FCFs 1,331.35 1,447.61 1,544.81 1,605.18 36,150.11

TotalEnterpriseValue= 42,079.06

A Note On Capital Structure

Walgreen Co. is an all equity financed firm. The company owns a mere ~18% of it’s store

base. The other ~82% is leased. These leases hold Walgreen Co. responsible for

$26.078 billion, but this obligation is not seen on the balance sheet as a liability to the firm.

This poses potentially risk to Walgreen Co. Lets call these lease obligations “quasi-debt.”

THEREFORE, it is important to keep in mind this accounting structure when valuing WAG.

Sensitivity Analysis

Most likely to range from 34.73 to 57.04

Growth Rate3.00% 3.50% 4.00% 4.50% 5.00%

5.50% 71.36 88.09 115.97 171.73 339.006.00% 59.13 70.07 86.48 113.84 168.556.50% 50.40 58.07 68.81 84.92 111.767.00% 43.86 49.51 57.04 67.58 83.397.50% 38.79 43.10 48.64 56.03 66.378.00% 34.73 38.12 42.35 47.79 55.048.50% 31.42 34.14 37.46 41.62 46.969.00% 28.67 30.89 33.56 36.82 40.909.50% 26.34 28.19 30.38 33.00 36.20

WA

CC

Portfolio Fit

Sharpe Ratioa measure of the mean excess return

per unit of risk in an investment asset or a trading strategy

Including WAG generates a higher Sharpe Ratio

Month AnnualRisk-free Rate 0.2% 2.3%Sharpe Ratio (Include) 8.6% 31.1%Sharpe Ratio (Exclude) 8.1% 29.2%

RCMP Fall ’06 Decision

500 Shares of WAG were sold last semester at $49.94. Why?Lease Obligations

• WACC was adjusted upward based on the risk of outstanding lease obligations

After this adjustment, the company appeared to be trading at a “significantly inflated price that, in the long term, could not be sustained.”

RecommendationHOLD.

Why?• Healthy management vision• Stable, growing company• Solid performer• Leader in its class

But what about these lease obligations and other business risks!?

• Acknowledge that every company has risk, with Wagreen Co. as no exception.

• We have already taken action as conservative investors by selling 500 shares.