This week the market has followed last week’s precedent pretty strongly, moving higher to mark the strongest one-month increase since 2015. Investors have seemed anxious to look for reasons to start buying stocks again, and while it can be argued that a lot of risks remain in place, this really looks like a case where investors are looking past near-term risks and into the longer-term, to the point in time that life – business, social and otherwise – begins to return to some semblance of normal.
It has always been in the market’s nature to move prices in anticipation of news, good or bad. That’s why the mantra, “buy the rumor, sell the news” so often seems to hold true. I think that also explains why the market seems be to overlooking truly bearish signs that emerged this week, both in terms of the latest unemployment report as well as the first entries of the latest earnings season, which in many cases have shown even bigger drawdowns than experts predicted. Some of that bearish view seems to be counterbalanced against other facts. For example, while the federal government authorized an additional $600 per week in unemployment benefits above and beyond normal, state-provided benefits, there have been logistical challenges in getting that money into the hands of the people that need it. The same has also been true in many cases of the hundreds of billions dollars made available in business lending to keep small businesses afloat. Those are near-term concerns that market seems to be counter-balancing against the broader perspective that those challenges will be overcome.
Additional news in the last couple of days that seems to have give the market a fresh new wave of optimism involved the first FDA-approved, COVID-19 saliva test along with encouraging signs on the anti-viral front coming from reports of very early stage clinical trials. Investors appear to be taking all of that information together as positive indications that, sooner or later, the fight against COVID-19 will be won and pricing stocks accordingly.
In the near-term, though, the truth is that restarting a national economy, even on a state-by-state basis, is a gradual process, just as making sure that everybody that needs to be tested for COVID-19 can get tested, and effective treatments can be made available as soon as possible to those who need them. That means that current stay at home, shelter-in-place measures aren’t likely to be lifted quickly, and restrictions on normal business activity will still be in force. From a consumer standpoint, I think that means that most of us are going to continue to restrict shopping trips to only those most essential of items, including grocery and household supplies and prescription medications (COVID-19 or otherwise). That continues to be a reason that I think it continues to make sense to focus on companies in the Consumer Staples sector. Walgreen’s Boots Alliance Inc. (WBA) is an interesting example.
WBA is a company that occupies both the retail pharmacy and food space, with a global footprint that under current conditions is both a strength and a weakness. The U.S. makes up 75% of WBA’s 2019 sales, with about 74% of that amount coming from Pharmacy (prescription drugs) and only 24% from Retail (non-prescription drugs, beauty, toiletries and general merchandise). Outside the U.S., however, Retail comprised 64% of that division’s total sales, with Pharmacy at just 36%. Retail sales have suffered across the globe because of the pandemic, but the boost in WBA’s pharmacy business in the U.S. has given the company a buffer against that effect, while in other parts of the world the reverse has been true. Additionally, over the last couple of years WBA has been challenged on multiple fronts, as companies like CVS have made ambitious moves to diversify their businesses, and AMZN has reportedly been making detailed plans to provide its own pharmacy service. Its response was to expand, acquiring 1,932 Rite Aid stores last year to drive revenue and earnings growth. In some areas, the result is impressive, such as growth in Free Cash Flow. In others, question marks remain, including the massive debt load the company assumed in order to complete last year’s acquisition. At the same time, the stock is also trading at a discount that might offer the potential for useful value and appears to be stabilizing nicely as the broad market rallies. Is it worth your time as a long-term, bargain basement buy?
Fundamental and Value Profile
Walgreens Boots Alliance, Inc. is a holding company. The Company is a pharmacy-led health and wellbeing company. The Company operates through three segments: Retail Pharmacy USA, Retail Pharmacy International and Pharmaceutical Wholesale. The Retail Pharmacy USA segment consists of the Walgreen Co. (Walgreens) business, which includes the operation of retail drugstores, care clinics and providing specialty pharmacy services. The Retail Pharmacy International segment consists primarily of the Alliance Boots pharmacy-led health and beauty stores, optical practices and related contract manufacturing operations. The Pharmaceutical Wholesale segment consists of the Alliance Boots pharmaceutical wholesaling and distribution businesses. The Company’s portfolio of retail and business brands includes Walgreens, Duane Reade, Boots and Alliance Healthcare, as well as global health and beauty product brands, including No7, Botanics, Liz Earle and Soap & Glory. WBA has a current market cap of $38.9 billion.
Earnings and Sales Growth: Over the last twelve months, earnings declined by a little over -7%, while sales increased about 3.74%. In the last quarter, earnings improved by 10.95% while sales were 4.31% higher. The company’s margin profile is very narrow; over the last twelve months Net Income was 2.51% of Revenues, and strengthened only slightly to 2.64% in the last quarter.
Free Cash Flow: WBA has free cash flow of a little over $5.6 billion over the last twelve months. This number has declined from August of 2018, when it was about $6.9 billion; but it also marks an improvement from late 2019 of a little under $1 billion, and translates to a healthy Free Cash Flow Yield of about 14.6%.
Debt to Equity: the company’s debt to equity ratio is 1.34, a high number that is reflective of the company high debt load. Long-term debt jumped from $11 billion in August of last year to more than $32.5 billion in the last quarter. By comparison, their balance sheet shows only $792 million in cash and liquid assets, meaning that both management’s ability to service their debt and liquidity are a concern.
Dividend: WBA pays an annual dividend of $1.83 per share, which translates to an annual yield of 4.23% at the stock’s current price. Management has increased the dividend over the last year or so, which most investors would mark as a positive; but given the concerns I’ve just outlined, there is a risk that management may been forced to reduce or possibly even suspend its dividend.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target around $62.60 per share. That means the stock is very nicely undervalued, with about 42% upside from its current price.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: WBA’s downward trend began in mid-November of last year, falling from around $63 per share to a low point at the beginning of this month around $40. From that point, the stock rebounded to about $46 before dropping back just a bit in the last few days. It now appears to be moving higher off of immediate support at around $43, with resistance at $46. A push above $46 should give the stock room to run to about $51 in the near term, while a drop below $43 could see the stock fall near to its 52-week and recent low below $40.
Near-term Keys: WBA’s valuation metrics look very tempting right now, and it is also true that company boasts some interesting strengths including strengthening Free Cash Flow and a stable (albeit narrow) margin profile. The company’s massive debt load remains a concern, but indications for the time being are that WBA should be able to service their debt without too much difficulty. A risk to that outlook, of course is that the longer the pandemic forces consumers to stay home and businesses to stay closed, the bigger the draw against the company’s balance sheet will be. That means that the smart way to think about using WBA, at least for now, is by focusing on short-term trades rather than long-term opportunities. If the stock drops below $43, consider shorting the stock or working with put options, with an eye on a profit target around $39.50 to $40 per share. If the stock’s current bullish momentum continues and pushes the stock above $46, consider buying the stock or working with call options with $51 offering a useful, quick-hit exit point.