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Walgreen Outlook Bullish After Solid Profit Growth

Walgreen rallied Tuesday after the nation's No. 1 drugstore operator beat Wall Street quarterly profit forecasts and gave bullish commentary about its Boots alliance and ObamaCare's impact.

The company earned 73 cents in its August-ending fiscal fourth quarter, beating analyst forecasts by a penny. Revenue rose 5% to $17.94 billion, just missing views for $17.95 billion, according to Thomson Reuters.

CEO Greg Wasson said in a conference call that Walgreen (WAG) made good progress in improving front-end store sales and said its Balance Rewards card program was the "fastest growing loyalty program in the world," with more than 85 million enrollees.

Front-end sales in stores open at least a year were up 1.6% in Q4, as traffic fell 1.9% but basket size rose 3.6%. Total same-store sales rose 4.6%. Prescription drug sales, which made up 63.9% of sales, jumped 6.1%.

Management said it has a 19.1% share of the retail drug market, a slight gain over the prior year.

Walgreen shares closed up 4.5% to 56.24 Tuesday, just below its Sept. 23 record high.

Management commented that stronger sales trends in August continued into September, easing concerns over slower traffic trends in stores' front end.

"They have been struggling and still are to a degree with traffic issues," said analyst David Magee of SunTrust Robinson Humphrey. He said part of the problem was that Walgreen had pulled back from promotions.

But Walgreen got more aggressive in the last few months, said Magee. At the start of its Q4, same-store traffic was down almost 3% but by quarter's end "they cut their traffic loss" to 1.9%.

But the higher promotional costs likely hurt the gross margin, which at an adjusted 28.9% was down from the prior quarter and earlier year, missing views.

"We don't view the (margin) downside as significant enough to derail the long-term story," wrote Goldman Sachs analyst Robert Jones in a Tuesday note.

It's been a year since Walgreen's conflict with Express Scripts (ESRX) was resolved, allowing Express Scripts customers to once again use Walgreen to fill their prescriptions. It's unclear how many didn't return.

As ObamaCare health exchanges opened for enrollment Tuesday, Walgreen was bullish about the Affordable Care Act's impact on its business.

"We certainly know there is going to be an increase in the number of people that get insurance but we are not speculating on what that number is," said pharmacy chief Kermit Crawford on the call. However, "overall, we anticipate benefiting from that in a number of ways.

Walgreen's earnings slowed in fiscal 2012 as it lost customers to rivals such as CVS Caremark (CVS). But they've been moving up since the February ending quarter, as have shares, which are up more than 54% this year.

CVS' stock, up 21% this year, rose more than 1% to 57.56. Rite Aid (RAD) climbed 4% to 4.93.

ISI analyst Ross Muken wrote in a Tuesday note that Walgreen's Q4 was the "final full quarter of favorable comps due to the annualization of the (Express Scripts) hold-out.

Some analysts pointed out that if a 3-cent legal benefit had been excluded, Walgreen would have missed Q4 earnings views by 2 cents.

Magee said it was a "minor negative offset by the fact important trends are heading in the right direction." Those trends, he said, are positive same-store sales, strong cost controls and "robust expectations" from Walgreen's 45% stake taken last year in Alliance Boots, the Swiss firm that runs the U.K.'s leading health and beauty retailer.

Alliance Boots contributed 8 cents to Q4 earnings. Synergies from the Boots alliance in the first year were $154 million, above Walgreen's forecast of $125 million to $150 million. Management expects Alliance Boots to kick in 5 cents in EPS in Q1, and $350 million to $400 million in synergies in fiscal 2014.

"They have equity exposure to a growing international entity that is rolling up pharmacy distributors overseas," Magee said.