Keep An Eye On Walgreens

| About: Walgreens Boots (WBA)

Summary

Short-term controversy can be a great catalyst to initiate a position in a stock.

Salad Oil Controversy with American Express in the 1960s is a great example.

Any controversy with Theranos and Walgreens could present a similar opportunity.

Previous articles touched on the concept of inventorying your wealth by storing it in high-quality blue-chip stocks. A large portion of this strategy is systematic stock purchases on a monthly basis, but we also are always looking for strategic opportunities to deploy cash. If a little investing history serves any basis, an opportunity may present itself in Walgreens-Boots Alliance (NASDAQ:WBA) soon.

Walgreens at a Glance

On paper, Walgreens is a great candidate to store wealth in for the long term. They have paid dividends since 1933 and have been raising them annually since 1976. Earnings are also increasing by merit of their recent acquisition of Boots Alliance, and look to further increase their earnings base with an acquisition of Rite Aid later this year. 12,755 stores located globally are operated under the brand's umbrella, which means there are 12,755 sources of earnings sending in cash annually. Nearly $90 billion is generated from these stores, $81 billion of which comes from the United States. The wholesale pharmaceutical division kicks in another $15 billion in revenue, and $376 million in operating income. The company is a powerhouse, and it is hard to dent the earnings in a significant manner given the geographic dispersion of the company's pharmacies.

With the above said, one of the greatest risks to Walgreens in my opinion would be reputational. As noted, the company has nearly 13,000 stores, and hundreds of stores would have to struggle in order to significantly affect the company's earnings. There is a risk of new stores cannibalizing existing store sales, but acquiring Rite Aid will allow them to close more competing locations and allow them to close other underperforming stores.

With a low risk of having too concentrated a footprint, any other risk will revolve around incidents that could keep customers en masse from coming to their stores. Chipotle experienced an event like this earlier this year when they dealt with outbreaks of E-coli and Norovirus caused by their food. Walgreens does not prepare food, but selling a faulty product that causes harm to customers could keep people away. Today, the specter of one such reputational risk raised its head.

Blood Tests and Salad Oil

First off, a little investing history is due. Controversy can be a great way to lower the valuation of a stock and can create opportune price points for initiating a position. Warren Buffett is famous for the risk he took on American Express (NYSE:AXP) back in the 1960's after they had been suckered by non-existent salad oil as collateral for a loan. The stock fell by 50% but the underlying business performance was still in place, which created a massive buying opportunity in a quality stock. Buffett did not hold that investment for forever, but it was his one of his first big investing achievements. Today, a similar opportunity may come at Walgreens due to forthcoming troubles with their partnership at Theranos.

Theranos is a blood-testing startup founded in 2003 that purports to be able to conduct dozens of tests using much less blood than a standard blood test would. It was a revolutionary claim, and they were able to raise money at a several billion dollar valuation. They currently operate dozens of wellness centers where they take samples, and a quick scan of the Theranos website will show that a large portion of them are located in Walgreens stores out west.

However, the wheels began to fall off early last fall. The Wall Street Journal launched an investigation that claimed Theranos had embellished the claims of its testing technology, and a few months later the company came under intense scrutiny from federal regulators. They were forced to void over two years worth of blood tests, tests that people could and did act on based on the results. Today, a class action lawsuit was revealed against the company. Before this all broke, Walgreens had sought to play a major role in the growth of Theranos through a mutually beneficial partnership. As noted earlier, Theranos had already opened testing centers in dozens of Walgreens in Phoenix and California, and plans had been made to expand the partnership nationwide. With this partnership, they would both seek to expand their respective businesses. These plans were all scuttled, however, after the revelations the partnership expansion was effectively put on hold.

The connection to Theranos was not great for company optics, but at the time it was not something that looked like it would harm Walgreens. However, recently in the Wall Street Journal it was revealed that Walgreens had performed little due diligence into the technology. They did not test the claims of Theranos proprietary Edison testing machine, never verified that test results from Theranos came from the Edison machine, and proceeded with the partnership even though they rarely received answers to questions they had for the startup. Walgreen's was not named in the class action suit, but that doesn't mean it won't be in some later suit after these revelations.

The Opportunity

One of the problems with Walgreens is it is a quality stock, and quality does not come cheap today. It is valued around 25 times earnings, and short a massive increase in earnings, the ratio does not to look fall anytime soon. However, the revelations today could create an opportunity to enter the stock. Like Amex in the 60's, the business performance of Walgreens is still in place, but perception of scandal can make short-term reality.

WBA was down 1.09% after the WSJ article broke, while the market was down .13%, and while a massive drop may not be imminent, short-term price weakness is not unwarranted. Look for uncertainty around the partnership to continue developing and have cash ready for any subsequent drops in price. There are two levels at which I consider buying: a 2% yield and a 20 PE Ratio. At a yield of $1.44 annually, this would make our first price target $72. At earnings of $4.00 annually last year, our second price target would be $60. This would be over 10% below the point at which I traded in and out of WBA (was WAG at the time) a couple of years ago, and would offer opportunities for capital appreciation.

Conclusion

Walgreens-Boots Alliance is an excellent company that rarely trades down, but is down 18% from its yearly high and has uncertainty related to its Theranos partnership. Look for price decreases related to the uncertainty, and subsequent attractive entry points. This would not be a short-term trade, but rather a place in which to store wealth for the long term at a good price point. Happy investing.

Disclosure: I am/we are long AXP.

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.