Streetwise for Sunday, April 14, 2019

While investment opportunities are always plentiful, you need to have a willingness to take decisive action with an overwhelming sense of self-assurance. Moreover, you must be able to stay the course despite the consternation of others. 

To paraphrase words from a Rudyard Kipling poem, can you can keep your head when all about you are losing theirs – and blaming you? Can you trust yourself when all men doubt you?

This has never been more applicable than in the case of Walgreens Boots Alliance (WBA). With over a 100-year history, its roots go back to 1848, Walgreens has 18,000 stores worldwide and 43 years of increasing dividends.

Walgreens, Duane Reade, Boots, Bo7, Soap & Glory, Sleek MakeUP, Botanics, and Liz Earle. Those are the companies that went into making Walgreens Boots Alliance.

Walgreens is one of the largest purchasers of prescription drugs and has a nationwide network of distribution centers, which manage drug deliveries to hospitals, pharmacies, doctors and the like. 

Not only is the company large, but it is diversified, owning a 26 percent stake of its own drug wholesaler, AmerisourceBergen (ABC), who has 20 percent of the entire market for pharmaceuticals sold and distributed throughout the United States.

The company’s business is split into three divisions, of which Retail Pharmacy USA is the largest generating over three-quarters of the company’s revenue and operating profit. The two smaller ones with 13 and 11 percent of operating profit, respectively, are Pharmaceutical Wholesale and Retail Pharmacy International.

Yes, Walgreens reported fiscal second-quarter results that fell short of expectations in what management described as the “most difficult” quarter since late 2014. 

Its earnings report was highlighted by a 10.4 percent decline year-over-year in operating income to $1.935 billion and a 2.06 percent gross margin contraction. Gross margins fell due to pharmacy reimbursement pressures.

Domestic same store sales growth did not meet expectations at both the pharmacy and front-end (the portion of a drugstore not selling drugs), while the performance in UK remained challenging.

Nonetheless, Walgreens chalked up a sales gain of 6.7 percent and organic sales growth of 2.5 percent. However, it was less than the 11.4 percent and 4.3 percent, respectively, in the prior quarter.

Nonetheless, management has detailed strategic initiatives to improve its performance, including raising its cost-saving program from $1 billion to $1.5 billion, accelerating partnerships and investing in digital technology.

Management’s 2019 outlook was lowered as the company expects earnings growth to be approximately flat, with its strategic initiatives likely to “bear fruit” in fiscal 2020.

Walgreens’ multiple headwinds are no different than what its rivals face. And Walgreens’ management appears confident it has the necessary initiatives in place to project a mid-to high-single digit growth in earnings per share after fiscal 2020.

While the company has felt the rapidly changing operating environment, its solid financial footing and cash flows will buy it time to adapt.

The balance sheet is strong, and the dividend payout is well managed – with a 43-year dividend growth history. Sales did increase 4.6 percent year-over-year to $34.5 billion, but earnings per share fell 8.3 percent year-over-year.

Nonetheless, the company is sitting on $980 million in cash against total debts of $15.99 billion. The company’s current leverage ratio of 1.88, comfortably below the 2.50 that would cause consternation.

Walgreens currently pays out a dividend of $1.76 per share which consumes only 28 percent of cash flows. What this means is that the dividend is safe. Management has adequate cash flow if operations continue to erode as the company adapts to its challenges.

The intrinsic value of the shares using free cash flow to the firm model is $207 versus a recent share price of $54.56. My earnings estimate for fiscal 2019 (year ends August 30) is $6.10 and $6.25 for 2020, with a projected 12-month share price of $61 for a 10 percent capital gain. The dividend yield is 3.18 percent.

Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com. Phone calls accepted between 9 AM and 3 PM at (941) 706-3449. For back columns please go to ww.RuddReport.com.