Walgreen Earnings Preview: Our Worst Trade Ever

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 |  About: Walgreens Boots Alliance, Inc. (WBA)
by: Brian Gilmartin, CFA

Summary

WAG seems overvalued at $65.

WAG weathered tough Midwest winter pretty well.

Business is changing.

Walgreen (WAG), one of the two premier retail drug store chains, reports their fiscal 2nd quarter, 2014, financial results before the opening bell on Tuesday morning, March 25th, 2014.

Per Thomson Reuters, the analyst consensus estimates coming into the release are for $0.93 in earnings per share (EPS) on $19.6 billion in revenue, for expected year-over-year (y/y) growth of -3% and +5% respectively.

Despite the tough January and February weather in the Midwest, monthly comp's weren't that bad, and the revenue estimate actually ticked a little higher since the December '13 earnings release. February comps rose 4.5%, with the front-end rising 2%, so WAG's "convenience" strategy and "just down the block" store locations might have benefited from customer's lack of mobility, thanks to the snow and cold throughout February.

WAG is a sensitive stock for me personally, for a number of reasons, which need to be disclosed to readers. We held the stock all through the 1990's for clients and did very well for client accounts, and then continued to hold the stock all through the 2000's when growth stock P/Es compressed and anything that did well in the 1990's got crushed. [This is what bothers me about those who get on CNBC and talk about the "tech stock bubble" in the late 1990's: yes, for sure technology as a sector was overvalued, but so were growth stocks like WAG, like Home Depot (NYSE:HD), like Wal-Mart (NYSE:WMT) and a bunch of others.]

The point being that when the whole Express Scripts (NASDAQ:ESRX) food fight blew up and WAG dropped to under $30, and it looked like management was going to take the company right to the edge, we sold all of our WAG.

Right near the multi-year lows ...

The Alliance Boots (AB) acquisition was puzzling too since it was thought WAG was overpaying for UK assets right when the euro and the EU was near its weakest and right in the thick of the Greece debt crisis.

The acquisition of the Duane Reade stores in New York I thought was a smart move. That retailer was thought to have huge "sales per square foot" metrics in their metro New York stores, but the stores were poorly kept, so applying WAG's model and display formats without losing that foot traffic seemed like a solid risk - reward.

I've always felt that WAG was one of the premier retailers in the US, but CVS (NYSE:CVS) forced some competitive changes to the sector and presumably the A/B and the Duane Reade acquisitions were a way to grow key metrics and profitability without a wholesale change to the business model as CVS did with Caremark.

Which brings us to today: from a valuation perspective, at least from a P/E perspective, WAG is trading at 19(x) the forward 2014 EPS estimate of $3.46. Using the consensus 2014, 2015 and 2016 EPS estimates, EPS is expected to grow 11%, 13% and 22% over the next three years (average is 15%) driven by expected revenue growth of 5%, 7% and 35%. (Fiscal 2016 for both EPS and revenues is showing current expected growth rates of 22% and 35% for the year, which must be a complete integration of the Alliance Boots business. I don't know what else it could be.)

At 14(x) and 31(x) cash-flow and free-cash-flow, the current cash-flow valuation is not very appealing either.

At .75(x) price (market cap) to 4-quarter trailing sales, WAG is trading below what is thought to be fair-value of 1(x) for a retailer, but is far more expensive at .75(x) than a Wal-Mart or Costco (NASDAQ:COST), with a narrower market niche.

Our own intrinsic value model puts a fair value on WAG at $61, while Morningstar's discounted cash-flow model puts an intrinsic value on WAG at $56. With the stock currently trading at $65, either model has the stock overvalued.

Technically, I'd love to buy the stock in the low $50's or the September '06 peak of $51.60, before it headed back down into the low $20's. That would be a steep drop for the stock. Once it traded under $55, it would get our interest.

To conclude our earnings preview, WAG is one of our worst trades ever. We were spooked out of the stock in the low $30's, high $20's. WAG is in the process of changing their business, moving firmly into the UK, trying to be more productive with their existing store footage.

I just do not like the stock at these valuation levels. Be patient.

Disclosure: I am long HD, WMT, COST. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.