- Buying above-average companies at below-average prices is generally a winning strategy.
- I highlight 2 such blue-chip companies whose stocks have been beaten down by the market.
- They are both paying well-covered and historically high yields, and are set up for potentially strong returns.
I would love to own stock in a company that has a moat, pays a decent dividend yield, has no uncertainties for the foreseeable future, and trades a cheap price. That would be wonderful, but guess what? Finding that type of opportunity is next to impossible, as the market wouldn’t let such an opportunity become cheap.
The point of value investing is to therefore embrace uncertainty and to use it to your advantage. This is how above average companies can be bought at below average prices. In this article, I’m focused on 2 strong moat-worthy names that pay decent, well-covered yields, and are trading at reasonably cheap prices, so let’s get started.
Pick #1: Bristol Myers Squibb
Bristol Myers Squibb (BMY) is a global pharmaceutical firm, with annual sales of $44 billion and an equity market cap of $132 billion. It’s undergone a transformation of sorts in recent years, shedding its lower margin businesses while pivoting towards higher margin specialty medicines. BMY’s Celgene acquisition in 2019 is an example of this transformation, pushing BMY further into the specialty pharma segment with cancer-targeting and anti-inflammatory drugs.
BMY’s stock price can’t seem to catch a break, as it’s seen a precipitous fall since mid-August, from the near $70-level to $59.15 at present. Nobody wants to buy a falling knife, and I see most of the weaker hands as already having folded. This is considering the support that the stock has seen at the current level since the last week of September. As seen below, BMY now carries an RSI score of 30, indicating that the shares are now in oversold territory.
While I can’t predict an absolute bottom, I do see the stock as being overly punished. This is considering that its sales are growing, and not declining, with 13% YoY revenue growth on a constant currency basis during the second quarter. This was driven by double-digit 11-29% sales growth amongst BMY’s blockbuster drugs Revlimid, Eliquis, and Opdivo. BMY’s expansion into the specialty business has done well for its margins. As seen below, BMY posted a sector-beating 42% EBITDA margin over the trailing 12 months.
(Source: Seeking Alpha)
Risks to BMY include the potential impact of drug pricing legislation. It’s worth noting, however, that this still needs to make its way through Congress, and nothing is set in stone. Plus, Morningstar sees only a limited impact to drug sales, as noted in its latest analyst report:
Upcoming congressional proposals on lowering drug pricing as well as a recent plan from the Department of Health and Human Services have put U.S. drug pricing policy back in the spotlight. We continue to see Medicare Part D redesign capping out of pocket costs of seniors and Medicare inflation caps as the most likely reforms to pass Congress.
We forecast a 50% probability of Part D redesign (potential 1% hit to U.S. drug sales) in our base-case scenario and an overall 4% hit from inflation caps in our bear-case scenario. While price negotiation can take many forms, we haven't seen a proposal that we believe is moderate enough to pass the razor-thin Democrat majority in the Senate and also be ambitious enough to gain the support of more progressive Democrats in the House.
Meanwhile, BMY maintains a strong A+ rated balance sheet, with $14B in cash and short-term investments, and a reasonably low net debt to EBITDA ratio of 1.7x. Management has reduced long-term debt by $5.8B since the start of this year. I view this, along with the fact that BMY carried a negative net debt balance prior to the Celgene acquisition, as being a sign of financially disciplined management.
This lends support to the 3.3% dividend yield, with a very low payout ratio of just 26%. It also comes with 12 years of consecutive annual raises. The dividend was raised by 9% last December, and I would expect another healthy raise in the coming months.
Lastly, BMY appears to be dirt cheap, with a forward PE of just 7.9 at the current price of $59.15, sitting well below its normal PE of 20 over the past decade. Analysts have a consensus Buy rating with an average price target of $75, implying a potential 30% total return over the next year. BMY is a Strong Buy.
(Source: F.A.S.T. Graphs)
Pick #2: Walgreens
Walgreens Boots Alliance (WBA) has a 120-year history and is a global leader in retail pharmacies. It has more than 21,000 stores spread across 50 U.S. states and 11 countries. Its 20% retail pharmacy market share in the U.S. gives it significant scale advantages, and WBA also has a 26% stake in the giant drug distributor, AmerisourceBergen (ABC).
WBA is another industry giant that’s been beaten down by the market. At the current price of $47, WBA is trading well below its 52-week high of $57, and its 5-year high of $86. As seen below, WBA saw a brief bounce in September before coming back down. While it’s not as oversold as Bristol Myers Squibb, it is approaching oversold territory with an RSI score of 41, as seen below.
Of course, a juggernaut like Walgreens doesn’t see material share price drops without headwinds. This includes a decline in gross margins from 30% back in 2013 to 20% over the trailing 12 months, as a result of ongoing reimbursement pressures related to generic drugs. Plus, PBMs (pharmacy benefit managers) have grown in size over this timeframe and now have more negotiating leverage over retail pharmacies.
However, I don’t see management just sitting on its laurels, as its recent agreement to increase its stake in Shields Health Solutions from 23% to 71% adds to WBA’s value proposition to hospital systems. Shields helps hospitals to develop onsite specialty pharmacies, and coordinate care plans for patients. It has partnerships with 65 health systems, and management expects the acquisition to be moderately accretive to EPS in the first full year.
In addition, there is the ever-present threat from Amazon’s (AMZN) entry into the pharmacy space, with mail-order prescriptions. However, WBA has demonstrated the need for physical retail locations, as it’s administered over 9 million COVID tests, and over 25 million vaccines, with 95% of locations administering shots. Plus, WBA has seen a solid bounce back in revenue, with it growing by 12% YoY.
Looking forward, I’m optimistic about WBA’s store transformation, as it continues to roll out its VillageMD offering. WBA is also ramping up its digital footprint with myWalgreens, and saw an impressive 34% YoY membership growth in the latest reported quarter. This helps to push WBA’s omnichannel capabilities, as it’s completed 6M curbside pick-up, drive-through, and last mile delivery orders since program inception.
Last but not least, management plans to deliver $2 billion in annual cost savings by FY 2022, and this could go a long way in further strengthening the balance sheet. At present WBA has a BBB credit rating with $1.3B in cash on hand and a net debt to TTM EBITDA ratio of 3.2x. I would expect for the leverage ratio to trend down as we move away from the pandemic months, and as cost savings come online.
Meanwhile, WBA is a dividend aristocrat that pays a high 4.1% dividend yield, which was unthinkable just 5 years ago, and carries a low payout ratio of 39.6%. As seen below, WBA is now sporting its highest dividend yield in over a decade (outside of an early pandemic timeframe).
(Note: The following chart is based on TTM dividend yield. Forward yield is 4.1%.)
I see value in the stock at the current price of $47.09 with a forward PE of just 9.8, sitting well below its normal PE of 14.1 over the past decade. Analysts have an average price target of $53, implying a potential 17% one-year total return. WBA is a Solid Buy.
(Source: F.A.S.T. Graphs)
This article was written by
I am Gen Alpha. I have more than 14 years of investment experience, and an MBA in Finance. I focus on stocks that are more defensive in nature, with a medium- to long-term horizon.I provide high-yield, dividend growth investment ideas in the investing group Hoya Capital Income Builder. The group helps investors achieve dependable monthly income, portfolio diversification, and inflation hedging. It provides investment research on REITs, ETFs, closed-end funds, preferreds, and dividend champions across asset classes. It offers income-focused portfolios targeting dividend yields up to 10%. Learn more.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of BMY, WBA either through stock ownership, options, or other derivatives. 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.
This article is for informational purposes and does not constitute as financial advice. Readers are encouraged and expected to perform due diligence and draw their own conclusions prior to making any investment decisions.
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