Walgreen (WAG) is the largest retail pharmacy in the United States. The company operates nearly 8,000 stores and recorded revenue of $72 billion in 2011. Walgreen's main competitor is CVS Caremark (CVS).
Walgreen stock currently trades at $29.57 per share, off from a high of about $45 per share in 2011. The current yield is 3.72%. Let's take a look at the ten-year dividend history:
| Year | Dividend | Growth |
|---|---|---|
| 2002 | $0.1463 | 3.54% |
| 2003 | $0.1613 | 10.25% |
| 2004 | $0.1913 | 18.60% |
| 2005 | $0.235 | 22.84% |
| 2006 | $0.285 | 21.28% |
| 2007 | $0.345 | 21.05% |
| 2008 | $0.415 | 20.29% |
| 2009 | $0.50 | 20.48% |
| 2010 | $0.625 | 25.00% |
| 2011 | $0.80 | 28.00% |
| 2012 | $1.00* | 25.00% |
*Dividend increase already announced.
The dividend has grown at an astounding rate over the last decade, increasing by over a factor of five since 2004. This kind of dividend growth is highly desirable. I'll calculate the payout ratio as a percentage of the free cash flow in order to make sure the dividend is sustainable.
| Year | Free Cash Flow (Mil $) | Float (Mil Shares) | Payout Ratio |
|---|---|---|---|
| 2002 | $539 | 1,032 | 28.01% |
| 2003 | $696 | 1,032 | 23.92% |
| 2004 | $713 | 1,032 | 27.69% |
| 2005 | $134 | 1,028 | 180.28% |
| 2006 | $1,102 | 1,019 | 26.35% |
| 2007 | $571 | 1,006 | 60.78% |
| 2008 | $814 | 996 | 50.78% |
| 2009 | $2,184 | 991 | 22.69% |
| 2010 | $2,730 | 988 | 22.62% |
| 2011 | $2,430 | 925 | 30.45% |
The average payout ratio over the last three years is just 25.3%. This is extremely low and means that the dividend has plenty of room to grow.
Valuation
I will use the Dividend Discount Model to put an estimated value on the company. This model assumes that the value of a company is purely the sum of all future dividends discounted back today. This is a reasonable valuation method if you are a dividend investor. The discount rate should be your required rate of return, and I will use a discount rate of 8%, which is roughly the long-term growth rate of the market as a whole.
Instead of assuming a future dividend growth rate and calculating a fair value estimate, it may be more reasonable in this case to do the opposite: calculate the future dividend growth rate which justifies the current stock price. I will assume that the dividend will grow at some rate for the next ten years, and then 3% after that, and my goal is to calculate that ten-year rate. With a current market price of $29.57 per share, this rate comes out to 8.14%. What this means is that if the dividend grows at a higher rate than 8.14% then the stock is currently undervalued.
Conclusion
With a yield of 3.72%, a historical dividend growth rate of over 20%, and a payout ratio of just 30%, Walgreen is significantly undervalued from a dividend point of view. As long as the dividend grows faster than about 8%, which appears to be a highly likely scenario, Walgreen at current prices is a bargain and would make a fantastic addition to a dividend-focused portfolio.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
