Justin Sullivan
Introduction
The stock of the integrated pharmacy, healthcare, and retail specialist- Walgreens Boots Alliance (NASDAQ:WBA), has been a source of wealth destruction for a long time now. After peaking at the $93 level in July 2015, the stock has been on a long slump, giving up 65% of its value since then, even as the market has delivered exceptional returns of 180%!
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Considering the long period of underperformance, investors may be apprehensive about considering this stock, but we think under the new CEO- Tim Wentworth (a seasoned professional in the payer and pharmacy space), there's potential for things to stabilize at WBA, and potentially improve over time.
As things stand, it looks like the investment community is quite divided about Wentworth's appointment and the decisions he has taken, and that's been reflected in the choppiness of the total return generated since he took over in October (aggregate returns of only +0.75%).
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Wentworth may have his task cut out, but we don't think the WBA stock deserves such a bad rap, given some of the silver linings we see.
Dividends and Cash Dynamics
One of the more unpopular decisions that Wentworth took was cutting the upcoming quarterly dividend (payable on March 12) by 48%. That was a real kick in the guts for a number of loyal investors who had come to bank upon WBA's dividend dependability for close to 5 decades! This decision will certainly lead to some re-adjustment of WBA's shareholder base, but it is worth highlighting that the smart money hasn't bailed in a meaningful manner. For context, the net shares owned by them are only down by a little over a percent.
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For what it's worth, do consider that WBA's new forward yield, even under the reduced payout, is still very competitive in the grand scheme of things. At $0.25 a share, you're still looking at a healthy forward yield of 4.5%; in contrast, the average forward yield of 180 odd consumer staple stocks works out to just 2.9%, implying a massive 160bps positive differential in favor of WBA. So it's not as if WBA is totally neglecting all its dividend-oriented investors.
Crucially, assuming the firm does not buy back its stock, at the current weighted average shares outstanding figure, you're looking at cash savings of close to $200m on a quarterly basis, or $800m annually.
Besides the $800m that will come from dividend savings, WBA will also get its working capital (WC) management in order, as it is currently well below what's expected. This is a business that has typically been able to extract cash benefits to the tune of $455m via working capital management, but as things stand, the situation is quite dire at nearly $700m of cash outflows. WBA management now hopes to bring through +$500m worth of working capital benefits for the year ending August 2024.
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This should do a world of good for the operating cash flow position, which will also likely cover a much lower CAPEX bill going forward. Already in Q1, we've seen the CAPEX bill drop off by around $100m, and the goal is to bring the outlay lower by $600m for the whole year.
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Note that typically this is a business that has generated FCF per quarter of almost $700m, but in recent periods it has lost that ability. With aggregate benefits (WC+ Capex) to the tune of $1.1bn on the anvil, we think WBA could be very well-placed to recoup its old FCF profile.
All in all, one is looking at close to $2bn of cash ($0.8bn on the dividends, $0.6m on the CAPEX, and $0.5m on the working capital) that could be very useful in bringing down WBA's heightened lease-adjusted net debt ratio of 3.5x.
Cost Base and Valuations
Under Wentworth's stewardship, you're also likely to see a leaner OPEX base. The company is shifting its cost base primarily to customer-facing activities, whilst trimming its support services workforce by 20%. There will also be productivity benefits on the supply chain front as WBA leverages AI with greater fervor. All in all, you could see around $1bn of cost savings come through within this fiscal itself (August year ending FY24).
These developments are poised to make a marked development on not just this year's expected EPS, but even over the next two years. After delivering a negative EPS of -3.57 last year, WBA is on course to deliver a positive EPS of $3.27 this year. Crucially, next year's consensus believes we could witness 9% earnings growth, and on that relatively strong base, we could see even better earnings growth of 13% in the following year!
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For a business that is poised to deliver such sturdy bottom-line growth through the next three years, it's worth pondering if it only warrants a forward P/E of just 6.1x. Crucially, that multiple also represents a sizeable discount of 37% relative to the stock's 5-year average.
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Closing Thoughts: Technical Considerations
WBA may also be considered on account of the favorable reward-to-risk equation that appears to be in play on both the standalone and relative strength charts.
Investing
On WBA's long-term chart which captures the monthly movements since 2015, we can see the price imprints have taken the shape of a descending broadening wedge pattern which suggests a reversal could be on the cards. You ideally want to play this pattern, when the price is closer to the lower boundary. Now if you don't have a great deal of faith in WBA's ability to re-test the wedge boundary highs (the black lines) of around $60, that's perfectly fair, but also consider that over the last three years, we also have another intermediate descending broadening wedge pattern playing out, with a much tighter and reasonable trading range (bounded by the two red lines). Over here, the price is a lot closer to the lower boundary, with a substantial gap from the upper boundary, implying solid reward to risk for a long position.
WBA's buy case is further strengthened by how oversold it looks relative to an equally weighted portfolio of consumer staple stocks. As things stand, the relative strength ratio is at record lows, and given that it is roughly 75% off the mid-point of its long-term range, we think it offers good prospects of mean-reversion.
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