Walgreens Boots Alliance (WBA, Financial) purchased $1.19 billion worth of AmerisourceBergen (ABC, Financial) stock in August after the organizations agreed to amend their business partnership.
According to the Philadelphia Business Journal, the 10-year deal that started back in 2013 was focused on streamlining the distribution of prescription drug products. The deal with Walgreens called for the company to act as its primary wholesale distribution source, according to AmerisourceBergen.
In review, AmerisourceBergen became Walgreens’ branded prescription drug supplier in September 2013. The drug distributor then started distributing Walgreens’ generic products in fiscal 2014. As of September 2014, AmerisourceBergen became Walgreens’ primary distributor of both generic and branded pharmaceuticals.
Walgreens, prior to its $16 billion (in approximation) merger agreements with Alliance Boots, accounted for 28%, or $33.5 billion, of total AmerisourceBergen fiscal 2014 sales. In fiscal 2016, Walgreens Boots Alliance accounted for 30%, or $44 billion, of the drug distributor’s revenue.
Equity ownership
As a result of the amendment, Walgreens Boots Alliance was able to exercise its warrants to buy more of AmerisourceBergen. Walgreens paid $1.19 billion to acquire more of AmerisourceBergen and now owns nearly 56.9 million shares of AmerisourceBergen common stock, which represents a 23.9% equity stake.
In review, warrants involved in the initial equity arrangements between AmerisourceBergen and Walgreens empowered the latter to have the right to purchase 16% of fully diluted outstanding shares of AmerisourceBergen. The warrants have $51.50 and $52.50 strike prices.
Earnings performance
AmerisourceBergen reported its fourth quarter of fiscal 2016 and year-end results on Nov. 2. The $17.4 billion medical distributor delivered 8% sales growth to $146.8 billion and profits of $1.4 billion compared to a loss of $138.2 million last year.
“We successfully navigated a challenging health care landscape, and we continued to enhance our offerings for customers and make important investments in our infrastructure.
“In fiscal 2016, we renewed relationships with key customers in our core business, we delivered excellent growth in our specialty businesses, and we had strong contributions from our most recent acquisitions, MWI Veterinary Supply and PharMEDium. In addition, we successfully mitigated the dilutive impact of the two warrant exercises, and we repurchased a total of $731.2 million in stock under our regular repurchase programs, a significant increase over our original expectation for fiscal 2016. We ended the year with an improved balance sheet, and we have significant financial flexibility as we head into fiscal 2017.” – Steven H. Collis, chairman, president and CEO of AmerisourceBergen
As a result, AmerisourceBergen shares appreciated 8.84%; the Standard & Poor's 500 index closed down 0.65%.
Meanwhile, AmerisourceBergen had five-year sales and profit averages of 12.9% and 15%.
2015 operations
In review of last year’s operation and as to why AmerisourceBergen delivered a loss compared to its positive results for the past decade, AmerisourceBergen had an observable increase in amortization, about 118%, related to its $2.5 billion MWI acquisition.
Also, warrant expense increased by 116% in fiscal 2015. AmerisourceBergen stated that the significant increase was primarily due to the increase of the company’s share price. These warrants were issued in March 2013 in connection with the agreements and arrangements that defined the company’s strategic relationship with Walgreens Boots Alliance.
Another marked increase in AmerisourceBergen’s expenses was in relation to its employee severance, litigation and other. In its filing, AmerisourceBergen identified much of the increase, $23 million of the $37.9 million, for the period as professional fees related to its deal with Walgreens Boots Alliance.
Valuations
AmerisourceBergen had a trailing 12-month price-earnings (P/E) ratio of 12.5 times (industry median: 21), price-book (P/B) ratio of 8 times (industry median: 2.4) and price-sales (P/S) ratio of 0.12 times (industry median: 0.89; 2). The drug distributor also had a trailing dividend yield of 1.76% and 22% payout ratio with 1.5% share buyback ratio.
Market performance
Year to date, AmerisourceBergen collapsed to -22.6% while the broader S&P 500 index returned 12.9% (3). Long term, AmerisourceBergen still outperformed the broader index with 18.2% versus 14.9%.
(Annual Report)
Cash, debt and book value
As of Sept. 30, AmerisourceBergen had $2.7 billion in cash and $4.2 billion in debt with a debt-equity ratio of 1.97, compared to $3.5 billion debt and 5.7 ratio in September 2015.
AmerisourceBergen also had 26.6% of its $33.7 billion assets in goodwill and intangibles while having a book value of $2.1 billion compared to $616 billion in September 2015.
(Annual Report)
Cash flow
(10-K)
AmerisourceBergen lost 19% to $3.18 billion in its cash flow from operations year on year. The company’s cash flow reduction associated with the benefits for deferred income taxes and lowered warrants expense contributed to this loss in cash flow.
Capital expenditures were $464.6 million, compared to $231.6 million last year, leaving AmerisourceBergen with $2.7 billion in free cash flow.
The company allocated 94%, or $2.55 billion, of its free cash flow in dividends and share repurchases. On average, AmerisourceBergen allocated 77% of its free cash flow in shareholder payouts in the past three years.
In addition, AmerisourceBergen allocated the majority of its cash flow in acquisition. In fiscal 2016, the company allocated $2.7 billion in relation to its PharMEDium acquisition. The company also had a positive net change of $713 million in debt. Also, AmerisourceBergen received $2.36 billion in cash flow from warrants exercise.
(Google Finance)
Conclusion
As observed, AmerisourceBergen was able to deliver good business growth year on year. In contrast, financial figures demonstrated a leveraged balance sheet. In addition, the agreement with Walgreens Boots Alliance also seemed to have diluted AmerisourceBergen’s shareholders in recent times. Competitor McKesson (MCK, Financial) also highlighted that there is an ongoing price war in the sector.
Given all these challenges, AmerisourceBergen provided a poor return this year.
Nonetheless, Morgan Stanley sees AmerisourceBergen as an overweight, while Mizuho rated the company as a buy and set a price target of $83.
In summary, AmerisourceBergen would be a speculative buy--but with limited upside (addendum).
Notes
(1) 10-K: MWI Veterinary Supply is the leading animal health distribution company in the United States, according to an AmerisourceBergen 2015 news release.
(2) GuruFocus data.
Morningstar data.
Disclosure: I do not have shares in any of the companies mentioned.
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