S&P Outlook: (1 Lowest - 5 Highest) 4

Fair Value: *$36.00

Risk: Average

Earn/Div Rank: A+

Technical Evaluation: BULLISH since 11/03

13-Wk Rel. Strength Rank (1 Lowest - 99 Highest) 62

Insider Activity: *Neutral
*

Overview *02-OCT-03

We see sales advancing about 15% in FY 04 (Aug.), fueled by the expected opening of 425 new stores, pharmacy same-store sales gains in the low to mid-teens, and front-end same-store sales growth in the low single digits. Despite likely sluggish front-end growth stemming from a more price conscious consumer, prescription sales growth should continue to benefit from an aging population, new drug introductions, and moderate drug price inflation. While net sales are expected to feel a 200-300 basis point impact from increased sales of lower priced generic drugs, the gross margin should benefit, as generic drugs carry wider margins than their branded counterparts. However, margins may be pressured as SG&A costs are leveraged across a smaller sales base due to generic sales substitution, employee costs increase, and lower margin third party prescription sales rise as a percentage of total pharmacy sales. In all, we look for FY 04 EPS to increase 17%, to $1.31, from $1.12 in FY 03, excluding one-time gains.

Valuation *02-OCT-03

We recommend accumulating the shares, as we believe industry valuations will benefit from continued strong prescription sales due to improving demographic trends. Prescription sales in comparable stores rose 9.9% in the FY 03 fourth quarter, benefiting from a rise in prescriptions filled as positive demographic trends continue to result in increased demand. The stock was recently trading at 23X our FY 04 EPS estimate, about 1.5X our projected long-term EPS growth rate of 15%, and at a premium to the shares of other drug chains that we cover. However, we believe the stock's above average multiple is justified by the company's long history of stable earnings growth, strong balance sheet, and leadership position within its industry. Additionally, with one-third of the company's store base less than three years old, we are confident in the company's ability to continue generating strong sales and earnings growth. Based on our discounted cash flow analysis and P/E multiple comparisons, our 12-month target price is $38.

Business Summary *02-OCT-03


Walgreen (WAG) has gained prescription market share in all but one of its 50 leading markets within the past five years. In FY 03 (Aug.), Chicago-based WAG, the largest U.S. retail drug store chain in terms of revenues and profitability, posted its 29th consecutive year of record sales and earnings. Sales increased 13% in FY 03, to $32.5 billion. Earnings before special items advanced 14%, to $1.16 billion.

In 1909, the company's founder, Charles Rudolph Walgreen Sr., purchased one of the busiest drug stores on Chicago's South Side, and transformed it by constructing an ice cream fountain that featured his own brand of ice cream. The ice cream fountain was the forerunner of the famous Walgreen's soda fountain, which became the main attraction for customers from the 1920s through the 1950s. People lined up to buy a product that WAG invented in the early 1920s: the milkshake.

WAG has long resisted the merger fever that has spread through the drug store industry. Instead, it stresses internal growth strategies: large-scale infiltration of new markets, and relocation of units to free-standing stores; and convenience, including 24-hour operations and drive-through pharmacy service.

As of August 31, 2003, the company operated 4,227 drug stores in 44 states and Puerto Rico, versus 3,880 a year earlier, with large concentrations of stores in Florida, Illinois and Texas. Internally, WAG is growing faster than any other drug store chain. It opened 430 net new stores (including closures and relocations) during FY 03. The company plans to open 450 units in FY 04, with a goal of 7,000 total stores by FY 10, up from earlier expectations of 6,000 stores.

Pharmacy sales accounted for 60% of total sales in FY 02, up from 58% in FY 01. WAG, which was already a leading dispenser of prescriptions in the U.S., boosted pharmacy sales 21% in FY 02, versus a 21% gain in FY 01 (with a gain of 11% for comparable drugs, versus 18%).

The company's technological advances include satellite linkage to all stores and facilities, point-of-sale scanning and implementation of the strategic inventory management system (SIMS), uniting all elements of the purchasing, distribution and sales cycle. This is designed to reduce inventory, improves in-stock positions, and provides faster reaction to sales trends.

Healthcare Plus, WAG's pharmacy mail-order subsidiary, offers sales, marketing and operational support for third-party retail and mail-order prescriptions through two facilities. The company has also formed a pharmacy benefits manager, WHP Health Initiatives, targeting small to medium-size employers and HMOs.

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Office--200 Wilmot Rd., Deerfield, IL 60015. * Tel--(847) 940-2500. * Website--http://www.walgreens.com * CEO & Chrmn--D. W. Bernauer. * Pres & COO--J. A. Rein. * SVP & CFO--R. L. Polark. * Treas--J. W. Gleeson. * Investor Contact--Rick Hans. * Dirs--D. W. Bernauer, W. C. Foote, J. J. Howard, A. G. McNally, C. Reed, J. A. Rein, D. Y. Schwartz, J. B. Schwemm, M. M. von Ferstel, C. R. Walgreen III. * Transfer Agent & Registrar--ComputerShare Investor Services, Chicago. * Incorporated--in Illinois in 1909. * Employees-- 141,000. * S&P Analyst--Joseph Agnese/CB/JWP