On the back of strong free cash flow, combined with steady growth, Walgreens Boots Alliance (WBA) offers contrarians a rare investment opportunity with margin of safety at $70 billion market cap, which investors arguably underappreciating.
Unusual costs related to the failed merger of Rite Aid (RAD), caused Walgreens to finish fiscal 2017 with GAPP EPS down 1% at $3.78. However, adjusted EPS increased 12.9% to $5.10. Meanwhile, Walgreens' forward fiscal 2018 guidance has a midpoint forecast of $5.55 adjusted EPS. Thus, investors might superficially consider this pharmacy, with its strong brick-and-mortar presence, to be trading at an inflated multiple at 19 times EPS; particularly during a period when the market is dumping all retailers, claiming that retailers cannot compete with Amazon (AMZN) - which is just nonsensical for two main reasons. Firstly, because Amazon is not a direct competitor to Walgreens. And secondly, because Walgreens has proven to have a strong market share - which management highlights to be roughly 20%.
While generally, I would tend to agree, that 19 times EPS is too punchy an investment in a company's stock, and that leaves investors with next to no margin of safety. However, not in Walgreens’ case. Not only has Walgreens Boots Alliance ably demonstrated through its financial performance that its business model is consistently highly free cash flow generative, it has also delivered several years of persistent growth – 3-year CAGR at 16%. These, together with management’s vision; point towards how shareholders might benefit from being long-term investors in Walgreens at its current price of $70 billion.
Regulatory hurdles prevented Walgreens from merging with Rite Aid. Thus, Walgreens did what it considered to be the next best thing, and acquired approximately 1940 stores from Rite Aid. While these stores are still being transferred over to Walgreens, they will in time offer a boost to Walgreens top line trajectory. Meanwhile, Walgreens ended Q4 2017 with rewarding results, driven by robust growth in its Retail Pharmacy USA, with comps up 3.1% compared with the same quarter a year ago. Which is particularly noteworthy, seeing as how Walgreens' Retail Pharmacy USA segment accounts for 75% of total sales.
Thus, in spite of Medicaid reimbursement pressure and the impact of generics, management believes that Walgreens is likely to benefit from long-term double-digit growth to its bottom line. Again, Walgreens’ track record strongly reinforces this forecast.
During fiscal 2017, Walgreens set out to repurchase $5 billion worth of stock. Many companies announce an amount of stock to repurchase, but never actually repurchase the full amount announced in their repurchase program. Walgreens not only announced a $5 billion repurchase plan in June 2017 - by October 2017 it was completed.
Upon completion, the company has now earmarked an additional $1 billion to be repurchased. Since these repurchases would have undoubtedly been given the go-ahead by CEO Pessina, who is also the largest shareholder via his family trust Alliance Santé Participations, one can expect that these repurchases are a signal that Walgreens must be considered undervalued.
Seen as how Walgreens has a history of not only fulfilling its repurchase program but doing so relatively quickly, one can reasonably assume that the $1 billion earmarked to be repurchased will be completed relatively quickly.
Walgreens' valuation at first impression does not immediately shout out as a bargain, but investors should note that Walgreens has had steady and consistent growth - with a 5 CAGR of 24% at EPS level. Unequivocally demonstrating that, in spite of a difficult and fast pace of change in retail, Walgreens’ market share remains strong which has allowed it to continues to grow its revenue stream.
As mentioned above, Walgreens' cash generating abilities are not squandered and under the direction of CEO Pessina, its largest shareholder, the company continues to actively repurchase its shares.
Which, together with steady top-line growth continues to significantly boost shareholders intrinsic value per share. In time, the market to recognize this undervalued company and satisfactorily reward its shareholders - particularly since Walgreens' stock has materially underperformed the S&P 500 (SPY) index in 2017 and investors look for new nooks and crannies that remain undervalued in a fully valued market.
Walgreens is currently trading with a depressed valuation as investors are unduly concerned about the effect that Amazon's online (and its rumored physical presence of pharmacies inside Whole Foods) might pose to Walgreens. However, the time to buy is when the market becomes fearful beyond reason. The idea that Amazon will kill all types of retail businesses are overblown; but for any remaining doubters in the investment community, they should look no further than Walgreens and how it continues to successfully navigate through its sectors’ headwinds.
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Disclaimer: Please do your own due diligence to reach your own conclusions.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.