Despite almost a 40% decline in Walgreens Boots Alliance’s stock (NASDAQ: WBA) since the beginning of this year, at the current price of around $35 per share, we believe Walgreens has a significant upside. Why is that? The key is Walgreens’ stock is still 47% lower than it was at the beginning of 2018. Our dashboard, Why Walgreens Stock Moved -45%?, provides the key numbers behind our thinking, and we explain more below.
Some of this decline over the last 2 years is justified by the roughly 17% decline seen in Walgreens’ net income margin from 3.5% in 2017 to 2.9% in 2019. However, earnings growth, on a per share basis was higher by 14%, driven by revenue growth of 16%, and massive share buy-backs. Specifically, the company has invested about $15 billion in repurchases since 2017, resulting in about 14% lower outstanding shares. For the nine month period ending May 2020, the company spent another $1.4 billion in share repurchases. While there was a decline in margins, revenue and EPS growth were strong. So what explains the drop in stock price? It was primarily the company’s P/E ratio.
Walgreens’ P/E ratio plummeted from about 17x trailing earnings at the end of 2017 to 13x in 2019. This can partly be attributed to lower margins as well as the company’s international retail business facing tough competition from online retailers. While Walgreens’ P/E is down to about 8x now, given the volatility of the current situation, there is a significant additional possible upside for Walgreens’ multiple when compared to levels seen in the past years – P/E of 17x at end of 2017, and 13x as recently as in late 2019.
So what’s the likely trigger and timing to this upside?
Walgreens is not immune to the current pandemic. The global spread of coronavirus has meant lower footfall in stores. Though Walgreens along with other pharmacies has seen a sharp increase in home delivery orders, that business is subject to added shipping costs, as well as a tough competition from online retailers, including Amazon. The company’s UK business, which was already struggling to compete with online retailers that offered discounts, was a big drag in the fiscal Q3 performance (fiscal ends in August), as it accounted for 46% of the overall impact on the quarterly adjusted operating income. Walgreens recorded a $2 billion impairment charge for its UK business in fiscal Q3.
While these factors explain the decline in WBA’s stock price this year, we believe it could see a significant upside from the current levels. Why is that? The company is carefully addressing the issues related to its international business. The company is working on its store closure program which should help improve margins in the long run. In fact, Walgreens is targeting as many as 200 store closures in the UK and a similar number for the US. This is part of Walgreens’ “The Transformational Cost Management Program,” which now aims at annual cost savings of $2.0 billion by 2022, revised from $1.0 billion when the program was first announced in Dec 2018. The overall program includes multiple initiatives – from store closures to changes in IT capabilities – that will help Walgreens improve net margins going forward. Additionally, the company’s massive buybacks, and an attractive valuation of just 7.5x expected 2020 earnings could result in a significant upside for the stock, in our view.
Over the coming weeks, we expect continued improvement in demand and subdued growth in the number of new Covid-19 cases in the U.S. to buoy market expectations. Following the Fed stimulus — which set a floor on fear — the market has been willing to “look through” the current weak period and take a longer-term view. With investors focusing their attention on 2021 results, the valuations become important in finding value.
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