Published by Nicholas McCullum on April 12, 2017
The consumer staples industry has historically been one of the best for providing strong risk-adjusted returns.
Investors can make these returns even better by buying shares of market-leading consumer staples companies at attractive valuations. Walgreens (WBA) fits this bill, with a current price-to-earnings ratio of 17.5 (using adjusted earnings).
Walgreens is a also strong dividend stock. It’s 41 years of consecutive dividend increases qualify it to be a Dividend Aristocrat – companies with 25+ years of consecutive dividend increases.
This article will analyze the investment prospects of Walgreens in detail.
Walgreens is a retail and pharmacy giant. The company was founded in Chicago in 1901 and has since grown to more than 13,000 stores in 11 different countries. Walgreens has a market capitalization of $89 billion and employs more than 400,000 people.
Walgreens’ business has changed dramatically over the past few years because of their 2014 corporate reorganization, which was a $9,3 billion transaction that combined the following entities:
- Walgreens: the United States’ largest drugstore
- Boots: Europe’s leader in pharmacy retail
- Alliance Healthcare: an international wholesale and distribution company
The pro-forma company enjoys a very globalized presence.
Today’s Walgreens operates in three primary segments:
- Retail Pharmacy USA ($21.8 billion of 72.9% of 2Q17 sales)
- Retail Pharmacy International ($3.1 billion or 10.4% of 2Q17 sales)
- Pharmaceutical Wholesale ($5.0 billion or 16.7% of 2Q17 sales)
Despite Walgreens’ sizeable venture into international markets with the Boots-Alliance transaction, the company’s Retail Pharmacy USA is still by far their largest.
Current Events & Growth Prospects
Walgreens recently reported its fiscal second quarter earnings. The company saw healthy growth, with adjusted earnings-per-share rising 7.7% in the first half of the year and 6.1% in the quarter.
These results were strong and in line with my long-term expectations for the company.
Walgreens is currently fighting to complete its proposed acquisition of the Rite Aid Corporation (RAD), which operates the third-largest drugstore chain in the United States. The deal was originally announced in October of 2015.
The deal has been delayed because of concerns from the Federal Trade Commission (FTC) that a Walgreens-Rite Aid merger would reduce competition in the retail pharmacy space. Accordingly, the FTC has mandated that Walgreens must divest 1,200 Rite Aid stores to Fred’s (FRED) after the transaction and allow 100 Walgreens executives to move to Fred’s along with the stores. For context, Rite Aid currently operates about 4,500 stores.
Despite these concerns, management is confident that the deal will be completed as planned. Walgreens CEO Stefano Pessina is on the record saying he expects the deal to close by the end of July.
Even if the merger does not close for some reason, I believe Walgreens is still capable of delivering solid growth. This is because the global population is aging. More consumers will be relying on prescription medications moving forward. This bodes well for Walgreens, a company that profits when individuals come to stores for prescription refills.
Competitive Advantage & Recession Performance
Walgreens’ competitive advantage comes from the company’s global scale. Walgreens has locations in 11 different countries, and this provides them with economies of scale which improves margins.
The company also benefits from convenient store placement which encourages consumers to fill their prescriptions at Walgreens locations. This competitive advantage will be enhanced if the Rite Aid acquisition closes, as management expects.
Walgreens is expected to perform well during recessions because of the nature of its business model. People need to fill their prescriptions regardless of the behavior of the broader economy. Walgreens’ sales should be minimally affected by economic downturns.
This belief is supported by the company’s financial performance. Walgreens reported positive earnings growth in all but two of the past fifteen years.
Source: Value Line
Walgreens also performed admirably during the global financial crisis of 2008-2009. The company’s earnings-per-share performance during this time period is listed below.
- 2007 Earnings-per-share of $2.03
- 2008 Earnings-per-share of $2.17 (6.9% increase)
- 2009 Earnings-per-share of $2.02 (7.2% decrease)
- 2010 Earnings-per-share of $2.16 (6.9% increase)
- 2011 Earnings-per-share of $2.64 (22% increase)
Walgreens’ earnings-per-share declined by only 7% during the worst of the Great Recession and rebounded to new highs only two years afterward.
Walgreens should perform similarly during the next downturn.
Valuation & Expected Returns
Walgreens’ future shareholder returns will come from valuation changes, current dividend yield, and earnings-per-share growth.
Over the past twelve months, Walgreens has reported adjusted earnings-per-share of $4.71. The company’s current stock price of $82.51 represents a 17.5 multiple of trailing twelve-month earnings.
Walgreens is expecting earnings-per-share of $4.90-$5.08 for fiscal 2017. Taking the midpoint of this range ($4.99) and Walgreens is currently trading at a 16.5 multiple of 2017’s expected adjusted earnings-per-share.
The following diagram compares how Walgreens’ current valuation compares to its historical averages.
Source: Value Line
While not a screaming value right now, Walgreens is likely trading just shy of fair value right now.
Walgreens most recent quarterly dividend was announced on January 26 in the amount of $0.375 per share for an annual payout of $1.50. Today’s stock price of $82.51 means Walgreens is priced at a forward dividend yield of 1.8%. Walgreens dividend is also very safe, with today’s dividend representing a payout ratio of 32% of trailing twelve-month earnings.
Walgreens is a low yield dividend stock right now, but we can say with near certainty that the company will continue to raise its dividend at a good clip moving forward. Walgreens has raised its dividend for 41 consecutive years, and its dividend growth over the past decade in particular has been very impressive.
Source: Value Line
Walgreens earnings-per-share will continue to be the main driver of the company’s total shareholder returns. The company has compounded its adjusted earnings-per-share at a rate of 12.8% per year over the past fifteen years. Looking ahead, I believe 8%-10% annual growth in adjusted earnings-per-share is a reasonable expectation for this company.
Looking ahead, I believe 8%-10% annual growth in adjusted earnings-per-share is a reasonable expectation for this company. These returns will be helped along by the company’s recently announced $1 billion share repurchase program, which is set to be completed by the end of 2017.
Putting this all together, Walgreens’ total returns will be composed of:
- 1.8% dividend yield
- 8%-10% earnings-per-share growth
For expected total shareholder returns of 9.8%-11.8% before the (likely positive) effect of valuation changes.
Walgreens’ near-term future is shrouded in uncertainty as investors wonder about the future of the pending Rite Aid acquisition.
However, Walgreens should continue to perform well even if the acquisition is not approved by the FTC. Walgreens has a strong competitive advantage stemming from its international store presence and operates in the recession-resistant retail pharmacy industry.
The company is also attractive from a quantitive perspective. Its below-average price-to-earnings ratio, robust earnings growth, and low payout ratio make it a favorite of The 8 Rules of Dividend Investing.
Regardless of the outcome of the Rite Aid merger, Walgreens is a buy.