Walgreens Boots Alliance (WBA, Financial) is a holding company that is engaged in retail pharmacy and health care. The company has three reportable segments: U.S. Retail Pharmacy, International and U.S. Healthcare.
The U.S. Retail Pharmacy segment includes the Walgreens business. The U.S. Healthcare segment of the company leverages a health care platform that is delivered locally and scaled nationally through clinically proven programs that are developed organically and strategic partnerships with businesses that are majority-owned by Walgreens, such as VillageMD, Shields and CareCentrix.
I think the company has a lot of potential with its expansion into primary care. Moreover, it is also suffering from some bad press. This has led to steep undervaluation in my opinion.
Recent results
Walgreens' recent positive results have been obscured due to Covid headwinds (it is now lapping the last of the quarterly revenue spike caused by Covid testing and vaccinations last year). The company is also facing a large charge for legal settlements for opioid lawsuits. For its part in the opioid epidemic, Walgreens took a $6.5 billion charge in the first quarter of 2023 without admitting liability. The opioid payment will be made to the U.S. states and tribes over the next 20 years.
However, the underlying operating business is performing better than headlines suggest. Walgreens reported solid fiscal second quarter results and now expects better growth ahead. The company achieved 4.5% sales growth in constant currency, despite facing lower Covid demand and investing in labor and the U.S. Healthcare segment. The company also made significant progress in its transformation to become an integrated health care provider by partnering with VillageMD and Summit Health, one of the largest independent provider groups in the country.
Walgreens maintains its full year guidance for adjusted earnings per share of $4.45 to $4.65. The company anticipates strong EPS growth in the second half of the year as it laps last year's peak Covid contributions and benefits from its strategic initiatives.
In the company's international segment, Boots continued to grow it revenues 16%.
The company continues to reduce the number of its brick and mortar stores and close underperforming stores under the onslaught of mail order and online pharmacies. The retail business is now evolving towards primary care (i.e. Doctor and Nurse Practitioner Offices with a Drug Store attached) and home care. The company has been growing its health care segment with a slew of acquisitions, buying Summit Health, Shields Health Solution and CareCentrix, and collaborating with Horizon Blue Cross Blue Shield of New Jersey. It is also participating in five clinical trials. Its pro forma sales grew 30% in the second quarter and it generated $3.6 billion in after-tax proceeds from its portfolio alignment.
Currently the health care business is in the build-out phase and it is not profitable, so most of its income is still coming from its retail operation.
| Earnings breakdown | ||||||
| Revenues | Operating Income | |||||
| Report Date | 8/31/2022 | 8/31/2021 | 8/31/2020 | 8/31/2022 | 8/31/2021 | 8/31/2020 |
| Scale | Million USD | Million USD | Million USD | Million USD | Million USD | Million USD |
| U.S. Retail Pharmacy | 109078 M | 112005 M | - | 5029 M | 5019 M | - |
| International | 21830 M | 20505 M | - | 726 M | 466 M | - |
| Retail Pharmacy USA | - | - | 107701 M | - | - | 4099 M |
| Retail Pharmacy International | - | - | 10004 M | - | - | 130 M |
| Pharmaceutical Wholesale | - | - | 23958 M | - | - | 980 M |
| U.S. Healthcare | 1795 M | - | - | -370 M, | - | - |
| Total | 132703 M | 132509 M | 141663 M | 5385 M | 5485 M | 5209 M |
Financial condition
The following diagram shows the company's recent balance sheet. Overall, the company's financial strength is mediocre in my opinion. It has declined over the last five years due to the company's continuing transformation from primarily a retail pharmacy/drug store to an integrated primary health care and pharmacy, which has mostly been done via acquisitions.
On the bright side, bankruptcy is not likely. The net debt to equity ratio of 37.8% is considered satisfactory. The debt-to-equity ratio has reduced from 55.6% to 44.1% over the past five years. Debt is well covered by operating cash flow, and the adjusted interest coverage ratio of 3.1 is stable.
The company faces intense competition in its retail segment. Not only does it compete with mass merchants such as Walmart (WMT, Financial), even online retailers such as Amazon (AMZN, Financial) are now reaching for a slice of the pie. The company also faces acute pressure from Pharmacy Benefit Managers (PBM's) which are part of the large HMO's (Health Maintenance Organizations) such as CVS-Caremark, Express Scripts and Optum-Rx. The PBM's are the middle men between payers and the providers and control the profit margins pharmaceutical suppliers like Walgreens can provide. Overall Walgreen's gross and operating margins have been declining for many years as the company is getting squeezed from multiple directions. However it now appears that after years of disruption by PBM's and online pharmacies, margins are settling down to a new normal towards a lower but more stable rate. This together with the opioid settlement positions the company towards growth again and hopefully better valuation.
 WBA Data by GuruFocus |  WBA Data by GuruFocus |
Valuation
Using the GuruFocus discounted cash flow (DCF) calculator, I plugged in a starting earnings per share of $4.50, which is the adjusted earnings per share guidance given by management for the current fiscal year. Using a discount rate of 8% and projecting growth of 4% per year for the next decade, I get a fair value estimate of $59.62 per share. This represents an excellent margin of safety for the stock.
The GuruFocus valuation panel show solid value for GF Value as well Projected FCF. The median PS Value however looks excessive.
Rosalind Brewer, the CEO of Walgreens, bought 10,000 shares at $33.95 per share at the end of March. The stock is bit lower as of this writing. Pessina, Alliance Santé Participations SA and its parent, NEWCIP SA, which is 100% controlled by Executive Chairman Pessina, holds ~144.79 million shares, representing 16.78% of Walgreens' outstanding common stock. Thus, insiders have a lot of skin in the game.
Conclusion
Overall I feel that the stock market is overly pessimistic of Walgreens's current business and prospects. The company operates a recession resistant business in a defensive sector and currently pays a great dividend of 6.12%. Walgreens is a dividend aristocrat, having paid out dividends for 47 years without fail. Cash flow appears to be sufficient for it to continue the streak.
While the company is unlikely to reach its former glory in the medium term, it is busy transforming itself into a vertically integrated health care player. The company is selling at a very undemanding forward price-earnings ratio of less than 7. Such low expectations sets the company up to deliver upside surprise as conditions normalize and the company puts the Covid cliff and opioid settlement behind it.
