When you filter through all the noise in news and market media, the one of the main questions throughout the year is when a new bull market will finally happen.
That, of course begs the question, at least to me, of how long the combined mix of economic headwinds that are inflation, supply constraints, war, and rising interest rates will continue. That hasn’t been the case so far, as interest rates have continued to climb, with the aftereffects causing ripples in different areas of the economy, from rising consumer cost (including on items like food) to last month’s abbreviated banking crisis.
In the U.S., intense competition over the last few years in the retail pharmacy space has spurred major consolidation, leaving just Walgreens Boots Alliance (WBA) and CVS Corporation (CVS) standing among recognized national pharmacies 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. Along with its merger with health insurer Aetna, 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, that became an outright acquisition of VillageMD into its corporate organization late last year.
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 companies like WBA and CVS, including the ways they are investing to differentiate themselves from their drugstore-focused competitors. Continued aging of the Baby Boomer generation, with Generation X moving into retirement age 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. That trend saw a temporary shift in the third quarter of 2022, as the stock rallied along with the rest of the market from a multiyear low at around $30 to peak in December at around $42 per share. The stock has dropped back from that point, including an overnight drop following the latest earning report that now has the stock sitting at around $28. Many of the pandemic-driven headwinds that had a positive impact on the company’s bottom line have faded, while management is also continues to drive significant investment in accelerating the buildout of their VillageMD care clinics. Those are factors that I think have contributed to the stock’s underperformance. What do they mean about the stock’s value proposition?
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 $24.8 billion.
Earnings and Sales Growth: Over the last twelve months, earnings declined by about -44.75%, while sales were 1.18% higher. In the last quarter, earnings shrank -16%, while sales grew by 1.58%. The company’s margin profile is normally razor-thin, and dropped into negative territory late last year, but is showing signs of improvement; over the last twelve months Net Income was -2.44% of Revenues, and improved in the last quarter, to 0.33%. The turn from negative Net Income on a yearly basis to positive Net Income in the last quarter is an encouraging sign; additional improvement in the quarters ahead would validate the idea that this isn’t a temporary occurrence.
Free Cash Flow: WBA has free cash flow of $1.2 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 $3.4 billion. The current number also translates to a modest healthy Free Cash Flow Yield of 4.99%.
Debt to Equity: the company’s debt to equity ratio is .30, which is a conservative number. Long-term debt has decreased, from about $10.6 billion a year ago to $8.84 billion in the last quarter. It is also noteworthy that the company’s long-term debt increased by about $900 million in the last quarter. The company reported $970 million in cash and liquid assets in the last quarter, which is a decline from $4.2 billion three quarters ago and $1.8 billion in the quarter prior. Debt management should not be a concern, however the decline in liquidity and Free Cash Flow, along with razor-thin operating margins are elements to keep an eye on and that could be a challenge if they persist in the quarters ahead.
Dividend: WBA pays an annual dividend of $1.92 per share, which translates to an annual yield of 6.74% at the stock’s current price. WBA also increased their dividend from $1.87 per share in 2021, and from $1.91 in 2022 – 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 $23.50 per share. That means the stock is overvalued, with -17% downside from its current price, and a useful discount sitting at around $19 per share. It should also be noted that at the beginning of the fourth quarter of 2022, this same metric yielded a fair value target of $52.50, $38 at the start of 2023, and $40 in the last quarter.
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 price activity over the last year. The diagonal red line traces the stock’s downward trend from a high in April of last year at around $47 to its low, reached in just the last week at around $28. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. The stock’s downward trend is extending in aggressive fashion, typified by the overnight drop last week from about $31 to $28 after the company’s latest earnings report. That puts current support at around $28, with immediate resistance at around $30, based on the last significant pivot low, which occurred in late may around that price. A push above $30 has limited upside, with next resistance sitting right around $31 per share. A drop below $28 should find next support at around $26, based on the current distance between support and resistance.
Near-term Keys: While WBA’s fundamentals are generally healthy, they are also showing some signs of deterioration that do think validate the idea of waiting for the next quarter or two to see if they can see improvement. They also support the reality that the stock doesn’t offer a useful value proposition at its current price If you prefer to focus on short-term trades, you could use a drop below $28 as a signal to consider shorting the stock or working with put options, with an eye on an initial profit target at around $26. The stock’s current, increasing bearish momentum makes a bullish short-term trade, either by buying the stock or working with call options, a very low-probability, and speculative prospect.