Walgreens Boots Alliance Inc (NASDAQ:WBA) is one of the Dividend Aristocrats.
The Dividend Aristocrats are a select group of 51 companies in the S&P 500 Index, with 25+ consecutive years of dividend increases. Walgreens stock is one of 350 dividend-paying stocks in the consumer staples sector. You can see the full list of all 350 consumer staples dividend stocks here.
WBA stock has increased its dividend for 42 years in a row.
But this is a challenging period for Walgreens. The stock has declined approximately 15% in 2017. But the pessimism seems unwarranted.
Walgreens has a strong brand, and is an industry leader. It still has room for growth moving forward and has a long history of annual dividend increases.
As a result, we believe Walgreens stock is an attractive buy.
Walgreens was founded all the way back in 1901. In its current form, the company was created when Walgreens merged with Alliance Boots in 2014 to create WBA stock.
The merger created the largest retail pharmacy in the U.S. and Europe. Today, Walgreens operates more than 13,200 stores in 11 countries.
Source: 2017 Earnings Presentation, page 21
Investor sentiment has waned over the past year, due to fears of rising competition from online retail giants like Amazon.com, Inc. (NASDAQ:AMZN).
This is a challenging time for all of retail. The rapid growth of e-commerce has put pressure on brick-and-mortar retailers.
However, Walgreens hasn’t skipped a beat. The company recently concluded fiscal 2017, and the results were very strong.
Walgreens reported 11% adjusted earnings-per-share growth for the fiscal year, thanks to a 3.3% rise in comparable-store sales. Adjusted for currency, earnings-per-share increased 13% in fiscal 2017.
The most recent quarter was particularly impressive. Walgreens beat analyst estimates on both revenue and earnings-per-share. Revenue came in above expectations by $220 million, while earnings beat expectations by $0.10 per share.
In the most recent quarter, pharmacy sales and prescriptions increased 5.6% and 8.7%, respectively, on a comparable basis for WBA stock.
Source: 2017 Earnings Presentation, page 6
The strongest areas of the business were the U.S. retail pharmacy and pharmacy wholesale segments, which increased operating profit by 6.5% and 31% last year, respectively.
There should be plenty of room for growth next year and beyond, thanks to organic growth, as well as a major recent acquisition.
Walgreens’ most important catalyst in the U.S. is to grow through new stores and customers. It will accomplish this through acquisitions.
For example, Walgreens recently acquired over 1,900 Rite Aid (NYSE:RAD) stores, three distribution centers, and related inventory, for $4.375 billion. Store purchases will be completed by early 2018.
The Rite Aid transaction will help Walgreens grow earnings in multiple ways. First, it will immediately add revenue growth, plus other financial advantages.
Source: 2017 Earnings Presentation, page 18
Walgreens is assuming the real estate obligation, but is not assuming any debt. And, the acquisition should also result in a tax benefit, from amortization of intangible assets.
There will be significant cost synergies to accelerate earnings growth from the acquisition. Since Walgreens and Rite Aid have nearly identical operations, Walgreens will be able to eliminate duplicated functions across the business. Walgreens expects to realize more than $300 million in annual cost savings by 2021.
For fiscal 2018, Walgreens expects adjusted earnings-per-share of $5.40 to $5.70. At the midpoint, earnings for Walgreens would increase 9% in 2018, which would represent another year of strong earnings growth.
The first competitive advantage for Walgreens is its scale. Walgreens has nearly 400 distribution centers that supply approximately 230,000 pharmacies, doctors, health centers, and hospitals.
Despite the difficulties facing retail, there is still an operational advantage of physical stores. Most of the U.S. lives within a short distance of a Walgreens store. As a result, it is very difficult for competitors to take market share from WBA stock.
Separately, Walgreens benefits from a strong brand, and operates in a stable industry. Consumers cannot go without prescriptions and health care products. This helps earnings stay afloat, even during recessions.
For example, Walgreens suffered only a slight decline in earnings-per-share during the Great Recession:
Walgreens grew earnings-per-share from 2007 to 2009. It followed up this performance with over 20% earnings growth in 2011. It is clear that Walgreens has a recession-resistant business model, which helps it continue to raise dividends each year.
Walgreens stock had an adjusted earnings-per-share of $5.10 in fiscal 2017. As a result, the stock trades for a price-to-earnings ratio of 13.9. This is a low valuation for a highly-profitable company with a strong brand, and leadership position in its industry.
In addition, Walgreens appears undervalued, relative to both the market and its own historical averages. The S&P 500 Index has an average price-to-earnings ratio of 25.
Over the past 10 years, Walgreens held an average price-to-earnings ratio of 17.3.
Source: Value Line
This means Walgreens is currently valued at a 20% discount to its 10-year average. This discount seems unwarranted, since Walgreens is still growing earnings at a healthy rate.
Therefore, the stock could experience an uptick in its price-to-earnings ratio, which would boost returns. If Walgreens stock traded up to its 10-year average price-to-earnings ratio of 17.3 from the current level of 13.9, it would yield a 25% return.
Plus, Walgreens will generate returns from earnings growth and dividends. Expected returns could be as follows:
In this forecast, total returns would reach approximately 10% to 12% per year, from earnings growth and dividends. But this does not include the impact of a rising price-to-earnings multiple.
As previously mentioned, Walgreens stock could return 25% if its valuation multiple returned to its 10-year average. If this took five years, it would add roughly 5% per year to Walgreens’ total returns. This would result in overall expected returns of 15% to 17% per year.
When it comes to retail stocks, there is a great deal of fear in the market. This is apparent, even for strong retailers like Walgreens.
Right now, Walgreens appears to be a classic case of “throwing the baby out with the bathwater”. Competitive pressures have caused the valuation to contract, but this could unwind as the fear subsides.
Walgreens is still a strong company, with a great brand and positive growth prospects moving forward. It should have no trouble raising the dividend each year. And, we view the stock as significantly undervalued.
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