There’s something about drugstores that have a unique appeal to most American consumers. Easy accessibility, immediate need products and a convenient location to pick up their latest pharmaceuticals. Roughly 66% of all U.S. adults utilize some form of prescription drugs, or approximately 130 million people. Yet most publicly traded drugstores don’t get the respect they perhaps deserve. The second-largest drugstore and pharmacy in the U.S. is Walgreens Boots Alliance Inc. (WBA, Financial), which is selling at irrationally low valuations.
Walgreens is a leading retail pharmacy chain with over 13,000 stores in 50 states and nine countries. The company's core strategy involves physical retail pharmacy locations in high-traffic areas, with nearly 80% of the U.S. population living within five miles of a location. The company’s market share of the domestic prescription drug market is approximately 18% according to 2021 statistics.
In 2021, the company sold off a majority of its Alliance Healthcare wholesale business to AmerisourceBergen (ABC, Financial) for $6.5 billion, doubling down on its core pharmacy efforts and ventures in strategic growth areas in primary care (VillageMD) and digital offerings. In addition, the company maintains equity holdings in AmerisourceBergen of 30% and Sinopharm Group (HKSE:01099, Financial) Guoda Drugstores in China of 40%.
Last year, the company announced it is initiating a strategic review of the Boots business. This is its British pharmacy business. Reports indicate a sale of this business could be valued in the range of $7 billion to $9.0 billion. Boots has approximately 2,200 stores with 47,000 total employees, mostly in the United Kingdom and other European countries.
Walgreens has a history dating back to 1901 in Chicago, where the company is still headquartered. The company garnered significant investor interest in 2018, with the stock reaching historic highs, but problems with its Boots subsidiary and other operating issues caused the stock to retreat 50% from those levels. The current market capitalization is $36 billion.
AmerisourceBergen relationship
AmerisourceBergen is an American prescription drug wholesale company that was formed by the merger of Bergen Brunswig and AmeriSource in 2001. It provides drug distribution and consulting to medical business operations and patient services. AmerisourceBergen handles about 20% of all of the pharmaceuticals sold and distributed throughout the U.S.
Through strategic arrangements and equity purchase agreements that date back to 2013, Walgreens now owns approximately 28% of AmerisourceBergen. In 2021, the two companies furthered their relationship when Walgreens sold its Alliance Healthcare business to AmerisourceBergen for $6.3 billion in cash and 2 million shares of its stock. Walgreens' stake is worth approximately $8.7 billion, which is also equal to roughly 23% of its market cap.
Financial review
The company experienced somewhat of a Covid-19 pandemic boost being a convenient and fast source for vaccinations. For the fiscal year ending August 2021, Walgreens delivered 34.6 million Covid vaccinations. Although not largely a money-making endeavor, it did increase store traffic.
Financial results for the three months ended February 2022 were strong against tough comparisons. Sales on a constant currency basis increased 3.8% while adjusted operating income increased 35.9% and adjusted earnings per share increased 26.5%. U.S. retail sales (non-pharmacy) increased 14.7%, which was driven by vaccinations and Covid testing. The company updated its total vaccination count which was 62.8 million by the end of the second quarter. Like most mature companies nowadays, Walgreens also has a cost-saving program called the Transformational Cost Management Program, in which it plans to deliver $3.3 billion in annual cost savings by 2024.
Walgreens maintains a relatively safe balance sheet with cash and equivalents of $1.9 billion and total debt of $13.3 billion. With expected Ebitda of $6.6 billion, the company’s leverage ratio is secure at 1.7 times. Expected proceeds from the sale of it Boots subsidiary should greatly strengthen the balance sheet by the end of the year.
Valuation
The company is facing numerous cost pressures and solid earnings per share growth is hard to come by. These include wage pressures on a national basis, the eventual decline in Covid-19 vaccinations and prescription drug price pressures.
Nonetheless, Walgreens should earn close to $5 per share in 2022 according to analyst estimates, which gives the company a single-digit price-earnings ratio. However, 2023 earnings are expected to be flat to down slightly based on the cost issues and Covid-19 issues slowly fading away.
The company pays a $1.79 annualized dividend, which is currently well above average at 4.22%. The payout ratio is only 35%. This should create some level of stability in the stock if the yield remains above 4%.
Guru trades
Gurus who have purchased Walgreens Boots stock or added to their positions include Joel Greenblatt (Trades, Portfolio), Bruce Berkowitz (Trades, Portfolio) and Steven Cohen (Trades, Portfolio). Gurus who have reduced their positions include John Hussman (Trades, Portfolio) and John Rogers (Trades, Portfolio).
Conclusion
Walgreens appears to be undervalued at current levels, but there are reasons behind the stock's cheapness. The absence of near-term earnings growth may weigh on the stock for quite some time. However, the above 4% dividend yield provides a fixed-income-like return while investors wait for earnings growth to return or for the company’s strategic plans to play out.
