It’s a bit interesting to me to see that while Healthcare stocks in general have performed well this year in no small measure due to the ongoing pandemic, 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 throughout the crisis 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.
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 behind 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), healthy 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 extended a multiyear downward trend that saw the stock touch a new low around $33 in October. The stock has rebounded from that point, and is now approaching near-term resistance at the top of its latest consolidation range. Given the length of the downward trend, the average, growth-oriented investor would unquestionably stay away from this stock; but that same trend, along with the stock’s favorable fundamentals, also makes tempting fodder for contrarians and value-focused investors. Have conditions finally turned favorable enough to make WBA a smart long-term bet? 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 $32.8 billion.
Earnings and Sales Growth: Over the last twelve months, earnings declined by a little over -28.6%, while sales increased about 2.33%. In the last quarter, earnings improved by almost 23% while sales were flat, but positive at 0.33%. The company’s margin profile is razor-thin, and has been narrowing throughout the year, which is a big red flag; over the last twelve months Net Income was 0.33% of Revenues, and strengthened to 1.07% in the last quarter.
Free Cash Flow: WBA has free cash flow of a little over $4.8 billion over the last twelve months. This number has declined from August of 2018, when it was about $6.9 billion, and about $5.6 billion at the beginning of this year; 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 15.37%.
Debt to Equity: the company’s debt to equity ratio is .58, which is a conservative number, but doesn’t tell an accurate story about the company’s financial flexibility. Long-term debt in the last quarter was $12.2 billion versus $516 million in cash and liquid assets. Liquidity is deteriorating, as cash was $792 million at the beginning of the year. Along with the company’s dangerously narrow margin profile, management’s ability to service their debt and maintain liquidity is a concern.
Dividend: WBA pays an annual dividend of $1.87 per share, which translates to an annual yield of 4.98% 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 be forced to reduce the dividend down the road. Suspending or eliminating the dividend seems unlikely, given the company’s long-term track record of dividend payouts, but it should be noted that management has suspended is share repurchase program to preserve cash.
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 $54 per share. That means the stock is very nicely undervalued, with about 44% upside from its current price. It is worth mentioning that earlier this year, this same analysis offered a long-term target price at $61.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The chart above displays the stock’s downward trend over the last two years; the diagonal red line traces that downtrend from a high at around $86 to a low just a little above $33 last month. It also provide the baseline for the Fibonacci retracement lines shown on the right side of the chart. Since late August, the stock has consolidated between resistance at around $37.50 and support at $33. A push above resistance at $37.50 could provide enough momentum to push the stock to next resistance at around $41, while a drop below $33 would mark a new multiyear low that already has the stock mining lows not seen since the beginning of the broad market’s ten-year rally starting in 2011. In that case, the stock could fall to anywhere between $27 to $30 per share.
Near-term Keys: WBA’s valuation metrics are compelling right now, but given the company’s troubling pattern of deteriorating Net Income, and limited, fading liquidity, I’m not willing to buy the stock’s value proposition. They are clearly prioritizing their dividend, which is good for income-focused investors, but the entire picture together should give you reason to think twice. Sometimes a cheap stock is just a cheap stock, and I’m putting WBA in the category of a value trap for now. If you prefer to focus on short-term trades rather than long-term opportunities, you could use a drop below $33 as a signal to consider shorting the stock or working with put options, with an eye on a profit target around $30, with an eye on $27 if bearish momentum picks up. If the stock can push above $37.50, you could take it as a signal to buy the stock or to work with call options, using $41 as a useful, quick-hit profit target on a bullish trade.