04/01/13 Covered Call Pick: Walgreen Co. (WAG)
Walgreen Co. is the largest drug retailer store in the United States, operating over 8,365 drugstores, as well as mail service and home care facilities in all 50 states as well ad D.C., Puerto Rico, and Guam. Founded in Chicago, Illinois in 1901, and now headquartered in Deerfield, Illinois, is one of the most recognizable pharmacies across the country, Walgreens. On top of their retail stores, Walgreen Co. also operates several online stores including Beauty.com, Drugstore.com, and VisionDirect.com.
Walgreen Co has a market capitalization of $45.2 billion with 947 million outstanding shares.
WAG currently pays a $0.275 quarterly dividend for a current yield of 2.3%
With a beta of 0.74, WAG currently trades with approximately 25% less volatility than the current market.
There are a few things that we really like to use as investing linchpins, and one of the biggest ones is trends. What is hot, and what is not. What is going to be the next big thing? What opportunity is out there that companies will take advantage of in droves? There is another type of trend though, and that is the inevitable trend. In the spirit of the old saying, "The only thing for certain is death and taxes," one of the things that we know for certain is that time will march on, and as people get older, people will get sick. As the baby-boomers all begin to reach elderly age at the same time, there will be a boon of sales in the healthcare, pharmaceutical industries, and nation-wide drugstore chains like Walgreens will benefit.
There is a lot to like in Walgreen's stock. The dividend yield is mid-range, but above that of the S&P 500. It has a return-on-equity of 14%, and an EPS Growth Rate is 7% which is solid for a retail services company. The P/E ratio is 18, trading at the upper-end of its 5-year P/E Range, yet when compared to its expected 2013 earnings growth of 22% (resulting in a PEG Ratio of 0.82) the stock is relatively cheap. When you consider the low debt on their balance sheet, and beta of less than 1, WAG becomes a good stable source of income for a conservative to moderate investor.
Walgreens is also focusing on expanding, opening 11 stores in February alone. The company also reached a long term agreement with drug wholesale company AmerisourceBergen, giving WAG an ownership stake in the company, and greater negotiating ability on prices for their bulk pharmaceuticals, as well as access to more specialized drugs.
Off of the search for stable yield, relative stock stability, and the company's growth potential for the year, WAG's stock has risen over 25% year-to-date. Despite this run, the stock has received multiple upgrades in the month of March, with Macquarie, Citi, and JPMorgan all upgrading the stock to "buy", "overweight", or "outperform". UBS and Cantor Fitzgerald both reiterated their "buy" ratings, and only Goldman Sachs downgraded the stock from "conviction buy" to "buy", still a positive rating for the stock. While there are some headwinds for the company moving forward, better price-point competition from big box stores like Costco (NASDAQ:COST) being one of them, Walgreens is looking like it will have a very nice year in 2013.
All of those firms we mentioned with positive ratings on WAG have price targets anywhere between $50 and $55, so far be it from us to set a target outside that range. We are going to be looking for a more conservative play on the stock, as a miss on earnings or revenue could throw some resistance up for the stock. That is why we are recommending buying WAG, and selling the October $50 out-of-the-money Call.
- Buy 100 shares of WAG @ $47.49 = $4,749 + Commission ($12.95) = $4,761.95
- Write 1 WAG October 2013 $50 Call @ $156 - Commission ($8.70) = $147.30
Note: Prices may vary from the time of post. Actual commissions paid will vary returns.
Static Return (Not Called):
(Call + Dividend)/Stock Price X (Days/Year)/Days to Expiration
(1.47 + (2*0.275))/47.62 X (365)/200
= 7.74% Static Return
(Call + Dividend + Strike Price - Stock Price)/Stock Price X (Days/Year)/Days to Expiration
(1.47 + (2*0.275) + 50 - 47.62)/47.62 X (365)/200
= 16.86% If-Called Return
Disclosure: Clients and/or principles of OakTree Investment Advisors may or will have an investment in the above positions, but only on the the same sides of the trades. The above numbers are analytic estimations based on information known at the time of this post. OakTree Investment Advisors does not guarantee the above, or any, result. All investment decisions should be made based upon individual's personal investment goals and risk tolerance.
Disclosure: I am long WAG.
Additional disclosure: At OakTree Investment Advisors we have used a covered call strategy since inception and have a long position in WAG and sold covered calls.