Walgreens Boots Alliance (NASDAQ: WBA) has been at the forefront of all sorts of financial media outlets this year, but for all the wrong reasons. The worst-performing Dow Jones stock this year has declined almost 20% in 2019 and nearly 40% since hitting a 52-week high of $86.31 in December 2018. Key catalysts in Walgreen’s dismal performance is the overall decline of brick-and-mortar, pharmaceutical prices and new forms of competition including online pharmacy from Amazon (NASDAQ: AMZN). Any substantial decline of this magnitude always raises questions of whether a potential opportunity has presented itself to investors.
The sell-off has been long-lived but may have reached its conclusion. Robust sales volumes and cash flow, an increasing dividend, and overall efficiency improvements condone a great buying opportunity between the 2019 low of $49.31 and second-quarter pivot of $55.04. Expect undervalued WBA shares to bounce back to the $65 to $70 range over the next six to 12 months.
A Woeful 12 Months
Source: Yahoo Finance
After reaching a 52-week high of $86.31 in December 2018, WBA shares have tanked as low as $49.31. After reporting fiscal second-quarter earnings that missed analysts’ estimates, WBA shares slid substantially with management warning of further headwinds going forward. Full-year earnings were revised for 2019 to deliver flat growth versus a previous forecast expecting 7% to 12% growth. WBA also attributed a same-store sales decline of 3.8% to a weak cold and flu season.
Summarizing Q2 2019 earnings:
Adjusted earnings of $1.64 per shares versus estimates of $1.72 per share.
Revenue of $34.53 billion versus estimates of $34.56 billion.
Net income of $1.16 billion ($1.24/share) versus estimates of $1.35 billion ($1.36/share).
Despite a dismal Q2, a stronger-than-expected Q3 report has sparked hope for investors after WBA reported Q3 revenue of $34.6 billion, an increase of 0.8% year-over-year and a full $70 million above Wall Street estimates. The success was credited to sales in WBA’s U.S. retail-pharmacy segment which increased 2.3% to $26.5 billion.
Hope On The Horizon
WBA’s financial position has remained fairly robust despite concerns from investors and analysts. The company’s dividend yield of 3.25% is still attractive as WBA continues to increase regular dividends on common shares, a feat they’ve accomplished for more than 25 consecutive years. With a rebound in same-store sales growth and a healthy cash position, one should only expect this trend to continue. Additionally, dividing WBA’s previous 12 months’ FCF per share by its current share price, we arrive at a 9.5% FCF yield for Walgreens. After subtraction of the current dividend yield, we arrive at 6.25%, therefore solidifying our expectation of rising dividends going forward. This strong cash position not only adds value through dividend increases, but has room leftover for organic expansion, share buybacks, and acquisitions the company deems worthwhile to compete in the retail pharmaceutical industry.
Source: Seeking Alpha.
Another key issue that sent share prices on their rollercoaster ride was the decline in generic drug prices coming from partnerships among retailers and distributors. New government regulations indicating new reforms to decrease generic drug prices also added to the effect. As pharmaceutical products and services are more inelastic than regular goods, this only put pressure on WBA’s profit margins without significantly increasing total revenue. However, the trend of prices is increasingly becoming more stable and Walgreens has worked diligently to increase volume to offset the price decline and increasing reimbursements effects. Furthermore, efficiencies relying on more throughput per pharmacist than competitors such as CVS (NYSE: CVS) will help WBA steer clear of these pressures sooner than expected.
The decline of brick-and-mortar retail has also sparked concern among investors. However, it's very important to note that customer traffic has decreased significantly less in pharmaceutical retail than most other forms of retail. Additionally, growing pressures on independent pharmaceutical retailers who can’t achieve the same scale and efficiency actually aids larger retailers such as WBA. As independent retailers continue to decline, the transfer of this market share has rapidly been snagged by companies such as WBA and CBS, especially with growing loyalty programs and larger store offerings aimed at being a one-stop retail solution for consumers. This trend will only continue going forward while continuing to increase foot traffic into stores in an effort to achieve more volume.
WBA has also positioned itself to fend off major competition from Walmart (NYSE: WMT), CVS, and Amazon. Initially, Walmart pressured the pharmaceutical retail industry on margins due to their efficient supply and distribution channels. In an effort to combat this, WBA has ramped up acquisitions to “squeeze out the middleman” and improve its own efficiency. Another key concern among investors and analysts is pharmaceutical retail’s pressure stemming from pharmacy benefits management that competitors such as CVS face, however WBA has largely remained clear of this avenue by focusing on the pharmacy business alone. Nevertheless, partnership costs with companies such as AmerisourceBergen (NYSE: ABC) and the associated integration costs have largely stabilized and have given WBA a platform to effectively compete with large players such as Walmart and Amazon.
Although WBA has largely been able to fend off Amazon and its PillPack program, new forms of online competition and a drastic change in consumer preferences may force WBA to once again rethink its strategy. PillPack has disrupted the industry by combining prescriptions together and shipping medicine to consumers all at once. Amazon’s capabilities in online user interfaces and built-up efficiencies have also pressured WBA’s margins. Despite this, CVS has already introduced a similar service while WBA is in the process of rolling out their own multi-drug dispensing service. Therefore, competition among these players in the online marketplace and consumer preference shifts to online pharmaceutical services will be an important trend to monitor going forward.
Walgreens shares are a buy and simply too cheap to ignore at this point. Walgreens still boasts about 20% of U.S. prescriptions and has largely fought off growing competition from established retailers such as Walmart and CVS and emerging retailers including Amazon. Costs associated with efficiency have largely stabilized and will allow WBA to recover margins in the face of lower drug prices. Increased store offerings and novel online services in the form of multi-drug dispensing services have also successfully attracted more customers as WBA continues to improve uponn being a one-stop solution for consumers. Taking on Amazon will be no easy feat, but a stable cash position, growing partnerships and acquisitions of relevant companies put WBA in a position to compete going forward. At an alarmingly low forward P/E ratio of 8.9, WBA shares are undervalued considering improved efficiencies, sales volumes, cash flows, and its commitment to a rising dividend. Buying in between the $49.31 and $55.04 range is optimal as shares appreciate towards the $65 to $70 range over the next 12 months as these changes materialize.
Source: Chicago Tribune.
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.