When you filter through all the noise about inflation, interest rates, and war, the big story in the stock market for 2022 really comes down to the drop to bear market levels that has taken down just about every sector of the economy. The big question that remains is whether the economy will actually follow suit and move into a concurrent recession.
What a shift from the attention and commentary that has dominated headlines for the past two and a half years! Russia’s unprovoked invasion of Ukraine and its resulting economic and political isolation from the rest of the world have been a primary focus, since the conflict has kept natural gas prices and crude prices high as the conflict puts an additional constrictor on global energy supply; that is, of course a secondary question next to the tragic human cost and questions about what the long-term effect in the area and on the global political stage will be.
While COVID has taken a back seat, the truth of course is that many of the questions and issues around it remain. While many of the business and social activities that were restricted, delayed, or deferred in 2020 and 2021 have resumed, COVID variants are still out there, and spikes in infections and hospitalizations continue to emerge and remain an area of focus for the healthcare community. While it may not demand the same kind of attention or level of resources that it has up to now, I do think that the Health Care sector is going to continue to be an area that smart investors should keep their eye on. That includes stocks in the Pharmacy/Drugstore industry; these were names, like Walgreens Boots Alliance (WBA) and CVS Corporation (CVS) that worked actively in the early stages of the crisis as a critical piece of the testing puzzle, providing COVID-19 testing spaces outside its stores with solutions that included drive-through tests. Pharmacies have also played in a role in providing testing and vaccination locations. For the biggest players, the last two years has also shifted their operational focus to expanding the scope of services and care they provide.
In the U.S., intense competition has spurred major consolidation among recognized national pharmacies, leaving just CVS and WBA standing and looking for ways to innovate to counter not only the competition from each other but also from other companies like Amazon, WalMart, and Costco, to name just a few. For both of these companies, evolution and transformation have become a primary theme. CVS is actively renovating and remodeling local retail locations into combined pharmacy and health care service centers in the form of MinuteClinic and HealthHUBs. WBA isn’t standing pat either, investing heavily to roll out full-service primary care clinics as part of a partnership with VillageMD, and then upping the ante even more late last year when they announced the outright acquisition of VillageMD into its corporate organization.
If you look at the overall market for the pharmacy space, it becomes pretty easy to see that long-term demographic trends are generally favorable for pharmacies. Continued aging of the Baby Boomer generation, with Generation X following not far behind in the next decade or two, means that demand for prescription drugs and related health care services 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) and healthy Free Cash Flow, it is interesting to look at the stock’s price performance.
WBA has been following a downward trend since April 2021, and so far in 2022 has fallen from a January peak at around $55 to its current price at around $38. Some of the pandemic-driven headwinds that had a positive impact on the company’s bottom line have moderated, while management is also driving significant investment in accelerating the buildout of their VillageMD care clinics. Those are factors that I think have contributed to the stock’s underperformance so far, but also that could signal the stock’s useful long-term opportunity. Does that mean the stock’s value proposition is worth paying attention to?
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 $33 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased by -36.4%, while sales were -4.2% lower. In the last quarter, earnings declined nearly -40% while sales also declined by -3.43%. The company’s margin profile is normally razor-thin, but is showing signs of deterioration; over the last twelve months Net Income was 4% of Revenues. In the last quarter, Net income weakened to 0.89%, leaving no room for error.
Free Cash Flow: WBA has free cash flow of $4.4 billion over the last twelve months. This number has declined from August of 2018, when it was about $6.9 billion as well as over the past year, when Free Cash Flow was about $5 billion. The current number also translates to a still-healthy healthy Free Cash Flow Yield of 13.33%.
Debt to Equity: the company’s debt to equity ratio is .35, which is a conservative number. Long-term debt has increased, from about $7.6 billion a year ago to $10.6 billion in the last quarter versus about $4.45 billion in cash and liquid assets. Liquidity is improving, as cash was about $1.9 billion in the quarter prior. The company’s improving liquidity suggests debt management should not be a concern, however the decline in Net Income are something to keep an eye on and could be a challenge if it persists in the quarters ahead.
Dividend: WBA pays an annual dividend of $1.91 per share, which translates to an annual yield of 4.96% at the stock’s current price. WBA also increased their dividend from $1.87 per share in 2021 – which is a sign of strength and a confirmation of the company’s status as a Dividend Aristocrat.
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 at around $55 per share. That means the stock is significantly undervalued, with about 44% upside from its current price.
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The chart above displays the stock’s price activity over the last year; the diagonal red line traces the stock’s downward trend from a high in January of this year at around $55 to its low this week at around $37. It also provide the baseline for the Fibonacci retracement lines shown on the right side of the chart. The stock appears to be trying to stabilize around its recent low, marking current support at $37, with immediate resistance at the previous pivot low seen in mid-June at around $40. A push above $40 should have room to rally to about $42.50, where the last pivot high occurred. A drop below $37 could see the stock drop to as low as $34 before finding next support, using the current distance between support and resistance as a reference point.
Near-term Keys: WBA’s valuation metrics are very useful right now, which means that along with the company’s generally solid fundamentals, I think this is a smart stock to pay attention to and consider as a long-term investing opportunity. The decline in Net Income is a concern, but I believe it is also attributable primarily to the company’s investments in building out its Village MD clinics – which I believe will help to keep the company competitive and give it an advantage in the long run over some of its competitors like Amazon and Walmart. If you prefer to focus on short-term trades, you could use a drop below $37 as a signal to consider shorting the stock or working with put options, with an eye on a profit target at around $34. If the stock pushes above $40, there could be an interesting signal to buy the stock or work with call options, using next resistance at $42.50 as a useful, quick-hit, bullish profit target, and $44 possible if buying momentum increases.