Good morning!

WBA/Yodi – You have Boots in Europe – have people stopped going?  I guess that guy doesn't like them but he still went there to get his shot.  Revenues and profits are back to 2019 levels, heading towards $4Bn per year and you can buy the whole company for $43Bn.  Do you know who you buy drugs on-line from in the US?  WBA!  The big pharmacies are also the big on-line sellers.

And look how crazy this is:

Are they going to have huge growth?  No.  Can we make 300% on a spread that's better than 80% likely to pay off?  Yes.  So I like them.  

You can sell 2024 $40 puts for $5 and that's net $35, which is $15 (30%) below the current price and would drop the PE down around 7 – so I consider that free money but, for a spread, I'd be more aggressive and sell the $50 puts:

• Sell 5 WBA 2024 $50 puts for $10 ($5,000) 
• Buy 10 WBA 2024 $35 calls for $15.60 ($15,600)
• Sell 10 WBA 2024 $45 calls for $9.50 ($9,500) 

That's net $1,100 on the $10,000 spread that's 100% in the money so start so all WBA has to do is not go lower and you make $8,900 (809%) in two years and that should cover your deductibles quite nicely.  Break-even is way down at $41, so WBA can drop 20% before you are out of pocket and worst case is owning 500 shares at $41.10 but then you can roll to lower strikes further out.  

So, you can keep hating on WBA all you want, Yodi, but I'm going to keep pointing out what an excellent value play they are.  

Walgreens (WBA) has certainly earned its title as one of the dogs of the DOW, given its underperformance and high dividend yield compared to its peers in the index. It’s easy to forget, however, that this stock was actually a Wall Street favorite just 4 years ago, with a share price in the mid-$80s and a healthy PE valuation.

While Walgreens has its share of headwinds, I believe the doom and gloom has been priced in, and see reasons to be optimistic about its future. In this article, I explore what makes WBA a worthy Buy in today’s expensive market for potentially healthy long-term returns, so let’s get started.

Why WBA Is A Buy

Walgreens Boots Alliance is a global leader in retail pharmacy with a 120-year history in this space. It has more than 21,000 stores in all 50 states and 11 countries, and was included in the Fortune 2021 list of the World’s Most Admired Companies. At present, WBA has the largest retail pharmacy market share in the U.S. at around 20%, giving it significant cost advantages and scale, and in addition, has a 26% stake in the drug distribution giant, AmerisourceBergen (ABC).

 

Starting with the negatives, it’s no secret that Walgreens has come under pressure in recent years, despite its scale advantages over smaller pharmacy chains. This is reflected by the decline in gross margins from just under 30% back in 2013 to 20% over the trailing 12 months. This was a result of ongoing reimbursement pressures as it relates to generic drugs and the growth in negotiating leverage that PBMs (pharmacy benefit managers) have over retail pharmacies.

Plus, the overhang of e-commerce juggernaut Amazon (AMZN) entering into the pharmacy space as well as the potential for an increase to the corporate tax rate only added fuel to the fire. These are the primary reasons for why Walgreens’ price has fallen substantially in recent years, and trades at a forward PE of just 10.7.

While these are legitimate reasons to be concerned, I do see reasons to be optimistic around the future for WBA. For one thing, the recent divesture of the Alliance Healthcare business (pharmaceutical distribution in Europe) to AmerisourceBergen enables management to be more focused around WBA’s core pharmacy business, while providing capital to fund business transformation efforts and pay down debt.

Walgreens has also proved the need for physical retail locations, considering that it’s administered over 9 million COVID tests, and over 25 million vaccines to date, with 95% of its locations administering shots. Plus, WBA’s revenue solidly bounced back during the third quarter (ended May ’21) with a 12% YoY increase, landing at $34 billion, which beat expectations by $560 million. It’s worth noting that WBA’s Q3’21 revenue now sits above the $29.9 billion in Q4’19 (pre-pandemic). Free cash flow also improved by 36% to $3.3 billion, and management is guiding for 10% EPS growth this year.

(Source: Q3’21 Investor Presentation)

Looking forward, I see a company in motion, as management aims to deliver $2 billion in annual cost savings by FY 2022. One of the ways to achieve this is by modernizing and automating its pharmacies, as highlighted by WBA’s investment in iARx, which aims to bring together pharmacy automation with enhanced workflow capabilities.

 

In addition, WBA is ramping up personalized offerings through membership of myWalgreens, which saw 34% YoY membership growth. This helps to enhance WBA’s omnichannel capabilities, with 6 million curbside, drive-through, and last mile delivery orders completed since program inception. Lastly, the company is making good progress in its business transformation efforts. This is reflected by positive market reception and accelerated rollout of its VillageMD offering along with expansion of its testing and diagnostics business inside stores, as noted by management during its recent conference call:

 

We are also accelerating our rollout plans with VillageMD following continued positive patient response. We have already opened 46 sites, and we have identified a further 35 locations to be opened by the end of this calendar year. This will bring the number of co-located sites to approximately 80 by the end of this calendar year.

In addition to these physical co-locations, we formed an integrated virtual healthcare collaboration with VillageMD in an additional nine Walgreens locations. This will give patients access to the same expanded pharmacy services that are available at the co-locations. Finally, building on our success in COVID testing, we are developing our testing and diagnostics business to provide a wider range of solutions for our customers going forward.

Balance Sheet and Dividends

Walgreens maintains a prudently managed balance sheet, with $1.35 billion cash on hand, and a BBB credit rating from S&P. It repaid $2.8 billion worth of long-term debt at the end of FY 2020, and currently has a net debt to TTM EBITDA ratio of 3.2x. I would expect for the leverage ratio to trend down, as we move away from the pandemic months of last year.

Meanwhile, WBA pays a relatively high 3.7% dividend yield with a low payout ratio of 39.7%. Let’s also not forget that WBA is a dividend aristocrat, with 46 years of consecutive annual raises.

The low payout ratio enables the use of retained capital to further business transformation efforts currently underway. As seen below, WBA’s dividend yield now sits at the highest level outside of the pandemic timeframe.

Note: The 3.6% yield is based on TTM. Forward yield is 3.7%.