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Wednesday, January 7, 2009

For Walgreen, Scaling Back Is Hard to Do

As posted by: Wall Street Journal

When sales falter, it makes sense to scale back expansion plans. That is, if you can. But Walgreen had geared its business model to growth in a way that will be tough to reverse as sales of prescription drugs and convenience-store items flag.

With the drug retailer posting its first ever decline in same-store sales in November, investors would probably react well to signs of reduced investment in new stores. But Walgreen plans to scale back only marginally.

The retailer still expects to increase square footage by 8% in fiscal 2009, just a whisker below the 9% average rate of recent years, and to hit 5% by 2011. Walgreen's stores usually lose money for about three years before turning profitable.

Walgreen's unwillingness to take its foot off the gas is partly because it can't. Its appetite for new store openings led the company to target prime locations and lock into lease agreements 12 to 18 months in advance. Walgreen says its current plans to cut back on new store openings will not force it to exit any leases, but more aggressive cuts could trigger penalties.

Big investments in distribution centers may also make it hard to scale back on store openings. In 2007, Walgreen invested $175 million in a South Carolina facility to support "expansion throughout the southeast over the next few years." A similar facility in Connecticut is scheduled to open next year. Those big centers need certain volumes flowing through them to make them work economically.

Walgreen is targeting $1 billion in cost cuts in other areas by fiscal 2011. But unless it can turn round its same store performance, investors should be wary of the retailer's continued rapid expansion.