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Has WBA found the bottom contrarians are looking for?

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It’s a bit interesting to me to see that while Healthcare stocks in general have performed well during the COVID-19 crisis, the gains don’t extend to every single stock in that sector. That’s isn’t altogether unusual; after all, no matter what direction the trend of a given sector may be, there are always outliers that buck that trend. The interesting part is to see that one of those outliers now is Walgreens Boots Alliance (WBA). Pharmacies like WBA and CVS Corporation (CVS) have been active about trying to provide a critical piece of the testing puzzle. WBA moved quickly to provide COVID-19 testing spaces outside its stores in mid-March, and in early April, they expanded that capacity to include a drive-through COVID-19 testing service.

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Long-term demographic trends are generally favorable for pharmacies, even outside the scope of the current pandemic. Continued aging of the Baby Boomer generation, and with Generation X following not far beyond in the next decade or two, demand for prescription drugs is expected to only increase. When you add in other fundamental factors like WBA’s long-standing status as a dividend aristocrat (members of the S&P 500 Index that have paid a dividend for 25 consecutive years or more), nicely improving Free Cash Flow, and an incredible value proposition, the question becomes why the stock has underperformed.

While most stocks in the Healthcare sector (including CVS) saw a nice rebound beginning in March, along with the rest of the market, WBA’s stock continued to slide lower; last week it hit a new 52-week low around $36.50 per share. That extends a downward trend that began in early November 2019, from a peak above $64. The stock is a bit higher now, suggesting that it might finally be starting to pick up some positive, bullish momentum. The average, growth-oriented investor would unquestionably stay away from this stock; but the current downward trend, along with the stock’s favorable fundamentals, also makes tempting fodder for contrarians and value-focused investors. Are the conditions favorable now for a long-term bet on this company’s future? Let’s find out.

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 $35.3 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 15.49%.

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 4.6% 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 the dividend. Suspending or eliminating the dividend seems unlikely, given the company’s long-term track record of dividend payouts.

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 $61 per share. That means the stock is very nicely undervalued, with about 53% 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 about a week ago around $36.50. From that point, has managed to rebound a bit, but appears to be running up against resistance at around $41 per share. Current support is around $38. A push above $41 could give the stock room to rally to between $43 and $45 where April pivot points could provide next resistance; strong bullish momentum could drive the stock all the way to the 38.2% Fibonacci retracement line shown on the right side of the chat at around $47 per share. If the stock drops below $36.50, it could fall to around $33 based on pivots last seen in 2012.

Near-term Keys: WBA’s valuation metrics are compelling right now, and it is also true that company boasts some interesting strengths including strengthening Free Cash Flow, a stable (albeit narrow) margin profile, and an attractive dividend yield at the stock’s current price. 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. If you prefer to focus on short-term trades rather than long-term opportunities, you could use a drop below $38 as a signal to consider shorting the stock or working with put options, with an eye on a profit target around $36, with an eye on $33 if bearish momentum picks up. If the stock can push above $41, you should take it as a signal to buy the stock or to work with call options, using a range between $43 and $45 as a first, quick-hit profit target, and with $47 as a secondary target if bullish momentum accelerates.

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