A dividend aristocrat with a forward dividend yield of 5.41% and trading at a P/E ratio of only 7.12, is Walgreens Boots Alliance (NASDAQ: WBA) a roaring buy today? Then again, what’s the story behind the fall in share price from $96 in 2015 to $36 today?
Business Overview
Walgreens is an integrated healthcare and pharmacy business with operations around the world (predominantly in the U.S.A, U.K., and Germany). It sells prescription drugs and retail products in the health and wellness sector. Its brand names include Walgreens and Duane Reade in the U.S.A., Boots in the U.K., and other stores in countries that include Germany, Thailand, Chile, and the Republic of Ireland. It also operates VillageMD clinics, including 146 co-located clinics, 124 standalone clinics, and 64 affiliate clinics.
Business Performance
Though it hasn’t been straight-line growth, Walgreens has grown its revenues by a respectable 85.2% between 2012 and 2022. More than half of this however, is due to a single event: Walgreens’s purchase of the UK’s Boots Company at the end of 2014. This acquisition alone boosted Walgreens’s revenues by more than $30 billion. In total, the purchase of Boots PLC cost Walgreens almost $9 billion in cash and another 227.7 million in Walgreens shares.
While gross profit has increased from $20.3 billion in 2012 to $28.3 billion in 2022, It’s operating income had fallen from $6 billion in 2016 to just $1.4 billion today. this is also due to the penalty ($5.7 billion over 15 years) that Walgreens has to pay after they are found liable for contributing to the opioid epidemic.
Earnings per share have also been growing, though not at a spectacular pace over the last five years, with a CAGR of about 3.27% since the acquisition in 2015.
Looking forward, analysts expect EPS for 2023 to fall to $4.50 in 2023 from $5.04 in 2022, and to rise only modestly in 2024 to $4.77.
Growth Prospects
In October 2021, Walgreens announced a new strategy of consumer-centric healthcare. This included the launch of Walgreens Health with investment in VillageMD and CareCentrix. It plans to transform its core business through:
- Expanding health and wellness personalization
- Becoming a lead provider of local clinical care services
- Leveraging its pharmacy network to deliver value-based care
- Strengthening partnerships with patients and providers
- Building a high-performance culture
It is hoping to make cost savings of $3.3 billion a year by 2024, and in doing so, expects annual adjusted EPS to grow by 4%. This growth will be dependent on Walgreens generating increasing returns. Beyond this, it hopes to deliver EPS growth of 11% to 13%, which will allow it to prioritize returning cash (i.e. dividends) back to its investors.
One cloud on the horizon is the reduction of sales of the Covid vaccine. In the second quarter, for example, it administered only 4.7 million vaccines, compared to almost 12 million in the previous quarter.
Dividend Profile
Walgreens has been increasing its dividend for every year since 2004. The current dividend yield of 5.2% is attractive and is well covered by its current earnings. However, its mediocre growth forecast of 4% in EPS may not give the company much room to raise dividends in the near term.
With the losses incurred during the last two quarters, its TTM payout ratio has increased to more than 75%, compared to a five-year average of 36.5%. Should the company experience another poor quarter, or other negative findings by regulators, the dividend could suffer – despite the company’s commitment to return cash to shareholders.
Business Risks
There are many obstacles to Walgreens achieving its own growth forecasts.
Its priority should be to reduce its operating costs, which are clearly damaging its operating profits. But as inflation continues to rise and labor becomes more challenging to hire and more expensive, this may be difficult.
In efforts to cut its cost base, Walgreens has attempted to sell some of its European operations, but has been thwarted by a poor market environment.
Additionally, the penalties it has occurred for its part in the opioid epidemic in Ohio may open the door to further lawsuits elsewhere.
And, of course, there is the steep reduction in demand for Covid vaccines, which looks set to continue as the risks of severe illness and death from Covid recede.
There is also the shadow of a harsh recession. As basic costs rise, consumers may be forced to focus their spending on essentials, such as food and energy. This could harm sales in higher-margin consumer goods, including the lucrative health and beauty market.
Finally, Walgreens’s foreign earnings are under threat. The strength of the dollar and the weakness of the UK economy specifically could damage sales in the Boots business, and serve up a poor performance when reported in dollars.
Final Thoughts
If you wished to buy stock purely for its dividends, then Walgreens may look like an attractive addition to the portfolio.
However, there are many question marks over the company’s ability to sell peripheral businesses and control its costs. Inflation is out of its hands, and it is transitioning to a business model that may promise higher margins but at the same time, is blighted by labor challenges at present.