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Robert Abbott
Robert Abbott
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Walgreens Boots: A Bargain Stock, But at What Price?

The merged pharmacy chain has several fundamental issues

July 08, 2020 | About:

The Walgreens Boots Alliance Inc (NASDAQ:WBA) please stand up pharmacy chain seems to be selling at a deep discount, many gurus have positions in it and it pays an attractive dividend.

Yet, when we look below the surface at its fundamentals, the company doesn’t seem so enticing, in my opinion.

The Walgreens Boots Alliance was born when two pharmacy giants, one in the U.S. and one in the United Kingdom, merged in 2014. The company now describes as follows in its 10-K:

“Walgreens Boots Alliance and the companies in which it has equity method investments together have a presence in more than 251 countries and employ more than 440,0001 people. The Company is a global leader in retail and wholesale pharmacy and, together with the companies in which it has equity method investments, has over 18,7501 stores in 111 countries as well as one of the largest global pharmaceutical wholesale and distribution networks, with over 4001 distribution centers delivering to more than 240,0002 pharmacies, doctors, health centers and hospitals each year in more than 201 countries.”

Note that "equity method" refers to a situation in which a company owns enough stock of another company to have a significant influence over it, generally a 20% to 50% stake.

Below is a 10-year price chart (prices prior to December 2014 were Walgreens alone). Since 2015, the share price has fallen by roughly 50%.GuruFocus Walgreens Boots 10-year price chart

To try to find out whether this is a good dividend stock at a great price or a weak company with a few good points, we will examine its fundamentals and dividends.

GuruFocus Walgreens Boots  financial strength

The company's financial strength is weak, as shown in the above table. The cash-debt ratio gives us an immediate hint, and we find that the company took on a load of long-term debt in 2015 and 2016, much of which it still carries.

GuruFocus Walgreens Boots long term debt chart

Part of the debt was incurred in the $4.4 billion acquisition of almost 2,000 Rite Aid (NYSE:RAD) stores and three distribution centers.

There is no immediate danger from the debt with an interest coverage ratio of 6.15, as it is generating enough operating income to pay its interest expenses.

GuruFocus Walgreens Boots profitability

There is also a slew of red on the profitability summary, indicating the company is not as profitable now as it has been in the past. In the second quarter the situation may have improved, but while sales and revenue were up in the first quarter, operating income and earnings per share were both down. On the bright side, the company’s Transformational Cost Management Program was making progress. According to the earnings report, the company is “on target to deliver in excess of $1.8 billion in annual cost savings by fiscal 2022.”

GuruFocus Walgreens Boots valuation

Where we do find lots of green is on the valuation summary, indicating the company is inexpensive compared to both its competitors and its own history.

The discounted cash flow (DCF) calculator shows Walgreens Boots has a nearly 20% margin of safety. That’s an estimate with which we can have moderate confidence, since the company has a three out of five star predictability score.

GuruFocus Walgreens Boots dividend and buybacks

At 4.34%, Walgreens Boots offers a dividend yield that is more than double the average of S&P 500 firms. In part, that’s because the share price has declined and made the dividend look better.

GuruFocus Walgreens Boots price and dividend yield chart

To some extent, the higher dividend yield reflects management policy. The company raised the dividend for fiscal 2020 by 4%, and we can lilkely expect more increases in coming years. It reported in its 10-K for 2019, “In July 2019, the Company’s Board of Directors reviewed and refined the Company’s dividend policy to set forth the Company’s current intention to increase its dividend each year.”

Walgreens Boots is paying out 46% of its earnings on dividends, and that’s a safe position because it leaves more than 50% of earnings available to invest in new income-generating projects. Sustainability of the dividend depends on parallel growth in free cash flow.

GuruFocus Walgreens Boots free cash flow chart

With free cash flow headed downhill since 2018, we have to be skeptical about dividend increases a few years ahead.

Over the past 3 years, the dividend has grown by an average of 6.9% per year, so it is growing faster than the rate of inflation.

This forward dividend yield is the same as the TTM dividend yield, meaning the company’s last increase took place before the most recent quarter. Watch for the next increase after Aug. 31, when the fiscal year ends.

The 5-year yield-on-cost is based on what happened to the dividend payments over the past five years, and indicates what investors might expect if they buy and hold the stock for the next five years, providing the company continues to grow the dividend at the same rate.

For Walgreens Boots, that’s an anticipated average growth rate of 5.95% per year. It does not include share buybacks or capital gains, so if we could count on it, it would provide a satisfactory base for future total returns.

Stock buybacks

The company has been enhancing shareholder returns with buybacks as well as dividends. The buyback ratio of 6.1 is calculated by dividing the amount of money spent on buybacks by the amount of market capitalization at the time the buybacks began.

A positive ratio, which is the case for Walgreens Boots, indicates the company is buying back more shares than it is issuing.

GuruFocus Walgreens Boots shares outstanding chart

Gurus

Eighteen gurus held positions in Walgreens Boots on March 31. The largest holding was that of Tom Gayner (Trades, Portfolio) of Market Gayner Asset Management, with 1,782,500 shares (after reducing his stake by 13.37% in the first quarter of this year).

The second largest holders also reduced their positions. Pioneer Investments (Trades, Portfolio) held 798,845 shares after reducing its stake by 39.74% and the Smead Value Fund (Trades, Portfolio) held 385,147 after cutting its stake by 53.89%

These gurus were not alone in trimming their holdings. This chart below shows the volume of guru buys and sells over the past two years:

GuruFocus Walgreens Boots volume of guru buys and sells

Conclusion

Walgreens Boots is a company with a strong dividend and record of buybacks. Combine the two and you have an attractive proposition for income investors, especially now that it is available at a discount to its intrinsic value.

Yet, I expect many income and value investors will hold back, waiting to see if the company can turn its growing revenue into growing profits, turn around the drift in its margins and reverse the direction of its free cash flow.

Disclosure: I do not own shares in any companies named in this article.

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About the author:

Robert Abbott
Robert F. Abbott has been investing his family’s accounts since 1995 and in 2010 added options -- mainly covered calls and collars with long stocks.

He is a freelance writer, and his projects include a website that provides information for new and intermediate-level mutual fund investors (whatisamutualfund.com).

As a writer and publisher, Abbott also explores how the middle class has come to own big business through pension funds and mutual funds, what management guru Peter Drucker called the "unseen revolution."

Visit Robert Abbott's Website


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