Walgreen (WAG) stock was hammered by about 15% Wednesday on news that … well, that Walgreen’s headquarters were going to stay right here in the U.S. of A.
WAG, which just acquired the remaining 55% stake in U.K. pharmacy retailer Alliance Boots, surprised investors by announcing that it wouldn’t be moving its headquarters to Switzerland, where Alliance Boots is located, but instead would remain in Deerfield, Ill.
Walgreen already held a 45% stake in its British counterpart, and the U.S. drugstore chain’s acquisition of Alliance Boots had been widely speculated. What jarred investors — who had enjoyed a 20%-plus gain in the stock for 2014 — was that they expected Walgreen’s so-called “inversion deal” to result in a move to Switzerland, which would improve WAG’s corporate tax rate.
Clearly, those tax savings were expected to significantly impact the bottom line, but is today’s selling in WAG stock perhaps a bit overdone? Let’s take a look.
What’s So Great About Switzerland?
Prior to today’s reversal, WAG stock was on a double-digit year-to-date tear, so the sudden drop might seem a little extreme. But Walgreen’s potential move was no small thing.
The hope was that by combining with Switzerland-based Alliance Boots, Walgreen would complete what’s known as a tax inversion. A tax inversion is a creative way for a company that does the majority of its business in the U.S. — where the tax rate at about 35% is among the highest anywhere — to reduce its federal tax obligation by taking on the residency of a company based in nation with a less burdensome taxes.
According to ISI Group, Walgreen just took $4 billion in tax savings over the next five years off the table by staying in Illinois. That’s capital that the company could have used to create more shareholder value.
However, investors might have been deflated for a couple of other reasons.
Scuttlebutt surrounding a potential tax inversion had escalated in recent days amid a change in top-level management. Chief Financial Officer Wade Miquelon is being replaced by Timothy McLevish, a former employee of both Kraft Foods (KRFT) and Ingersoll-Rand (IR). The speculation of a tax inversion grew in light of McLevish’s experience working for the latter company, which is headquartered in the tax haven of Bermuda.
Earnings guidance left something to be desired, too.
“Clearly investors thought [an] inversion was likely and that EPS guidance for 2016 would be far better than what materialized today,” Ross Muken, ISI Group Senior Managing Director and Partner, told InvestorPlace. Walgreen is calling for revenue in 2016 of between $126 billion to $130 billion, excluding joint ventures and other items, and adjusted earnings per share of between $4.25 and $4.60 per share.
Muken lowered his fiscal 2014 earnings outlook for WAG to $3.35 per share from $3.36 per share, and fiscal 2015 earnings guidance to $4.05 per share from $4.10 per share, citing margin pressure and a higher tax rate.
Still, there were a few sources of optimism for WAG stock holders.
Walgreen also launched a $1 billion, three-year cost-reduction plan, as a result of which the company expects benefits to materialize in fiscal 2015 and in response to which Muken lifted his fiscal year 2016 earnings guidance. He supports WAG stock at 14 times 2016 earnings without the benefit of the tax inversion savings. Walgreen currently trades at 18 times fiscal 2014 earnings estimates.
Meanwhile, Walgreen announced a $3 billion share buyback program to unfold through 2016, and a 7.1% rise in the quarterly dividend to 33.75 cents per share. Walgreen is guiding for a long-term payout ratio of 30%-35%.
In the case of WAG stock, it seems the more things change, the more they stay the same. Walgreen still is up against the same economic and industry headwinds it faced before, and it will be battling them out of its old Illinois digs.
But Walgreen’s renewed commitment to investors in the way of the dividend hike and share buyback program — while not the $4 billion in tax savings investors were hoping for — should ease worries a bit.
So even though Walgreen isn’t jumping on the tax inversion bandwagon, there are still reasons to like WAG.
As of this writing, Gerelyn Terzo did not hold a position in any of the aforementioned securities.