Walgreens Stock: Selling Boots Could Revive Wall Street Interest (NASDAQ:WBA)

Walgreens To Close Five San Francisco Locations After Rampant Shoplifting

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Walgreens Boots Alliance (NASDAQ:WBA) has been a chronic underperformer for many years. Once considered a growth retail darling like Walmart (WMT) in the 1980s and 1990s, operating results have disappointed for quite some time as a function of fierce competition and too much debt on the balance sheet. However, the valuation is now incredibly cheap. The easily covered 4.5% dividend yield is hard to ignore. And, the company has a number of moving parts and assets with misunderstood worth by the average investor. For bottom fishers like myself, buying a small position has plenty of logic behind it, even if additional short-term downside appears.

The best news and catalyst for a stock bottom is Walgreens is preparing to sell its British Boots pharmacy assets in the coming months, which could bring in as much as US$7 to $9 billion in cash to repay debt or redeploy to growth initiatives. A successful Boots sale should allow management to refocus the company on American stores and consumers (82% of sales and 90% of income generation the last two quarters). Several reports have two, if not three, potential buyers finalizing serious bids by the end of May. The mainstream financial press is anticipating Apollo Global (APO), Asda/TDR Capital, and possibly India’s Reliance Industries will be the likely suitors.

At the end of February 2022, the company held $16.8 billion in current assets vs. $22.7 billion in current liabilities, $21.9 billion in future rent obligations, and $11.2 billion in long-term debt. In summary, $5 billion in annualized cash flow generation over the last four years at WBA remains a low/weak number vs. a net long-term liability total of $44 billion (total liabilities minus current assets). The nearly 9x ratio of net long-term liabilities vs. trailing 12-month cash flow is excessively high measured against an S&P 500 blue-chip multiple average closer to 5x.

Additional ideas to munch on, 73% of U.S. sales are categorized as pharmacy related vs. 27% for general retail. AmerisourceBergen (ABC) is the main wholesale source of pharmaceuticals to Walgreens, selling $30 billion in goods to the company over the first six months of fiscal 2022. In terms of cross ownership, WBA held 28.2% of Amerisource Bergen, approximately 58.8 million shares at the end of February (worth $8.9 billion at the current $151 ABC market quote).

Weak Performance Scaring Away Investors

Honestly, the fast-money crowd has left Walgreens for dead the last couple of years, despite record profitability during the COVID-19 pandemic. WBA has reported an all-time high $6.2 billion in after-tax operating income and asset gains, about $7.27 per share over the trailing four quarters.

In the health care delivery and major retailer sectors, Walgreens has been one of the weakest investments to hold since 2017. It’s not difficult to understand why share owners have sold, or remain disgusted and upset at management. Below are 1-year and 5-year graphs comparing total returns vs. peers and competitors in the larger capitalization space. This list includes CVS Health (CVS), Rite Aid (RAD), Walmart, Target (TGT), Amazon (AMZN), Dollar General (DG), Kroger(KR), AmerisourceBergen, McKesson (MCK), Cardinal Health (CAH), and Laboratory Corp. of America (LH).

Walgreens total return vs peers

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Walgreens total return vs peers

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Nevertheless, on a bullish note, technical momentum indicators are starting to behave better. Specifically, the drop in price on Friday to new 52-week lows was not confirmed by creations like the daily ADL, NVI or OBV indicators. I have circled in green, bottoms in each of these momentum signals since early December.

WBA chart

1-Year Chart, Daily Value with Author Reference Points – StockCharts.com

Record Low Valuation

The main argument to buy Walgreens now is it has reached a record low valuation in late April 2022. Years of negative stock price trends have combined with flat to slightly better underlying fundamentals to create today’s undervaluation. You can review on 10-year and 35-year graphs drawn below how the WBA valuation picture on trailing operating metrics is very attractive right now. Looking at price to earnings, sales, cash flow, and book value, this could be a once-in-a-generation buy opportunity for a leading national U.S. brand-name pharmacy chain.

WBA PE ratio

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WBA PE ratio

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Even considering Walgreens heavy debt load (including future rents), when we cross record earnings in 2021-22 with a multi-year stock price low, a bargain ratio of enterprise value to earnings before interest, taxes, depreciation and amortization exists today. You can see below the 5.4x EV to EBITDA multiple is far below the peer and competitor group median average of 11x, or the S&P 500 closer to 16x (not pictured).

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Looking forward 1-year to 2023 expectations by analysts on Wall Street, price to EPS remains amazingly cheap. A projected 8.7x P/E is the lowest of the group and far away from the 13x median average.

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EV to revenues of 0.38x for Walgreens is more typical vs. peers, but still represents about HALF the level of five years ago. Lower final margins are the reason why, a direct result of extra leverage and interest expense.

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Cash flow generation to total debt is also on the weaker side vs. the peer group. The easiest way to lift WBA’s valuation over the short run would be a simple strategy of paying off debt rapidly. If the company receives cash for Boots and uses it exclusively to extinguish debt, it may become difficult for stock quote to decline much from $42 a share. My thinking is Wall Street analysts would rerate the remaining, more profitable U.S. operations at a higher valuation on improved margins overall.

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Lastly, final profit margins are low vs. the average S&P 500 business, but not horrible against health care delivery and major retail peers. For example, final income on sales of 4.8% is currently a better number than closest competitor CVS, or Walmart and Kroger (more lower-margin food sales), while just under the level for Target and Dollar General.

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Worthwhile Dividend Yield

After the lowball valuation story, the next best reason to own Walgreens is its terrific annual dividend yield. Income investors will love the 4.5% dividend rate on $42 per share, more than TRIPLE the peer group median average and equivalent S&P 500 rate of 1.4%. It’s also well above the entire Treasury bond yield curve, with “fixed” coupons mostly in the 1% to 3% range today. If management can get growth going again, dividend hikes are coming with even stronger distribution check amounts sent to your mailbox or brokerage account.

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Wall Street is so bearish on Walgreens right now, it is largely ignoring the powerful dividend proposition. On record profits, WBA has a strong dividend cover of 3.8x over the past 12 months, pictured below.

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The running payout rate at 45% of cash flow generation is admittedly higher than I would prefer, but again the Boots sale proceeds and simple positive effects from rising inflation in America should keep earnings and cash flow around record levels in 2022-23.

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Below is a chart comparing the Walgreens trailing dividend yield since 1995 to the same available yield from the SPDR S&P 500 ETF (SPY). While WBA typically sold at a premium valuation before 2012 (from expected above-average business growth rates), including a lower cash yield vs. the general U.S. stock market, that began to change markedly in 2019. Today, we have reached a near-record positive yield spread for the company, standing almost +3.1% above the equivalent S&P 500 cash distribution rate on new investment.

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Store Focus Reimagined

I have my own view on some ways to increase shareholder value, after selling Boots. The main idea is to leverage its network of prime real estate locations, in heavy traffic areas of each town or city, and rebrand itself as a top health and wellness destination.

Think about it, not only can you pick up your prescription, but each location could become an extended-hours source for basic primary doctor care. Walgreens is already hard at work on this complimentary concept (CVS is doing the same). The VillageMD partnership and 63% majority ownership acquired in November 2021 aims to put thousands of Village Medical Primary Care doctor offices next door or as part of remodeled Walgreens locations.

https://www.villagemd.com/who-we-are

VillageMD Website

https://www.villagemd.com/who-we-are

VillageMD Website

Another angle is to refit and restock its extensive local chain of retail locations to sell more beauty and wellness products instead of food and general merchandise, which could strongly differentiate its business vs. CVS or Walmart/Target stores. What if local Walgreens were not only your pharmacy and doctor of choice, but a top spot to find various health products, vitamins and supplements, shampoos, lotions, cosmetics, grooming supplies, fitness equipment, and more.

Given the proper Walgreens wellness push, management might weigh the advantages of putting a small yoga/aerobics studio into some floor plans, or an eye-doctor office, or even a hair/nail salon. All told, a Walgreens strategy moving toward a health center for local residents could be the winning play today vs. lots of shelves selling candy, toiletry and household goods with only minor sales daily.

Final Thoughts

Another asset shuffle idea would be a merger between Walgreens and AmerisourceBergen. Such could successfully and profitably stabilize and consolidate sales around pharmaceuticals, both in wholesale and retail supply channels. ABC is a close second for market capitalization size and total sales to McKesson on the wholesale delivery of medical products and prescription drugs to the U.S. health care system. Given Walgreens already owns 28% of the company, purchasing another 22% to gain 50%+ voting control with a consolidation of accounting results would cost an estimated $7.5 billion at the current ABC share price (roughly equal to the estimated Boots proceeds in a cash sale or 1.5x years of cash flow generation for WBA).

My point is Walgreens inherently maintains a variety of avenues to improve consumer health and wellness retail options to drive sales and income growth, beyond the basic pharmacy approach. It could further and easily consolidate the pharmacy supply chain under one roof. Plus, its vast real estate empire allows for greater financial flexibility (including many fixed and contract-rate rents) as inflation rates soar. The 4.5% dividend yield appears to be one of the smarter income opportunities available on Wall Street today, triple the S&P 500 yield, with future payout raises supported by general inflation in the U.S. economy.

What are the downside risks on investment? While the business is somewhat recession proof, with the majority of sales originating in the pharmacy, a deep recession may be the primary risk that could bring lower sales, cash flow and income, particularly if debt/leverage remains abnormally high. The second biggest direct risk to the stock quote is a weaker economy and rising interest rates continue to pull all U.S. equities lower, including WBA. The bear market of 2022 has not been kind to the Walgreens share quote, and this potentially could continue for months.

What about competition from Amazon? Wall Street is worried Amazon is getting into pharmacy sales online, and will likely steal some market share initially. However, last week’s bearish Q1 Amazon report and lowered guidance for 2022 means its hands are full with a slowing economy. And, if Walgreens moves further into a health/wellness focus, just blocks from your house, Amazon may actually not be a huge immediate threat for expert in-person advice and sales.

For contrarian investors with a penchant for deep value blue-chip positions, Walgreens could be a screaming buy today (or in the coming weeks on yet lower quotes). I do not own a stake as of this writing but am formulating a buy plan during early May. Without doubt, WBA is a ticker symbol demanding more in-depth attention by serious long-term investors, especially the income-hungry crowd suffering from interest rates still amazingly low vs. modern financial market history.

Thanks for reading. Please consider this article a first step in your due diligence process. Consulting with a registered and experienced investment advisor is recommended before making any trade.

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