Published November 10th, 2016 by Bob Ciura
Walgreens Boots Alliance (WBA) is the result of a $9.3 billion merger between Walgreens and Alliance Boots, which was completed in late 2014. The deal combined Walgreens, one of the largest drugstore chain in the U.S., with Boots, a major European retail pharmacy, and Alliance Healthcare, a large European wholesaler and distributor.
The companies have long operating histories and have built hugely successful businesses over time. Alliance Boots got its start in 1849, when John Boot opened an herbal remedy store in Nottingham, U.K.
Walgreens was founded in 1901, when Charles R. Walgreen Sr. purchased the Chicago store where had had worked as a pharmacist.
Walgreens Boots Alliance is a Dividend Aristocrat. You can see the entire list of Dividend Aristocrats here.
Earlier this year, Walgreens Boots Alliance raised its dividend by 4.2%. Including its predecessor company Walgreen, this was the 41st consecutive year of a dividend increase.
Bringing the companies together created a global behemoth. Walgreens Boots Alliance now operates nearly 13,000 stores in more than 25 countries. The company has over 370,000 employees.
Source: Fiscal 2016 Results, page 17
Business conditions for Walgreens Boots Alliance remain strong, particularly in the U.S.
The company’s constant-currency revenue grew 16% in fiscal 2016. Earnings-per-share, adjusted for one-time costs, rose 18% for the fiscal year.
The company’s domestic pharmacy segment was its best-performing group last quarter.
Source: Fiscal 2016 Results, page 8
The reason for this high growth is that the company is benefiting from a structural tailwind in the U.S. This is, the aging population. There are 75 million Baby Boomers in the U.S.; as the generation ages, it will likely cause rising demand for health care.
This tailwind has provided Walgreens Boots Alliance with strong growth for many years. Over the past decade, the company grew earnings-per-share by 8.4% compounded annually.
The main growth catalyst for Walgreens Boots Alliance is margin expansion. The company hopes to squeeze out significant cost synergies from its huge merger, to boost earnings-per-share. Management has reported successful results in this regard thus far:
Source: Fiscal 2016 Results, page 6
Plus, Walgreens Boots Alliance isn’t stopping there. Last year, it struck a deal in principal to buy major U.S. competitor Rite Aid (RAD) for $17.2 billion.
Management has a sound rationale for the merger. Buying Rite Aid will benefit Walgreens Boots Alliance by strengthening its grip on the U.S. market.
Source: 2015 Investor Roadshow Presentation, page 4
This will provide Walgreens Boots Alliance with immediate revenue growth (Rite Aid generated $31 billion of revenue last fiscal year). And, Walgreens Boots Alliance anticipates $1 billion of cost savings to be realized over the first three to four years after closing.
This is why, if the deal receives regulatory approval, the company expects it will be accretive to earnings-per-share in the first year upon closing.
Competitive Advantages & Recession Performance
The most obvious competitive advantage for Walgreens Boots Alliance is economies of scale. That was one of the biggest motivations for the huge merger.
Today, the company operates more than 340 pharmaceutical distribution centers, which supply more than 180,000 pharmacies and other customers.
Walgreens Boots Alliance has an $88 billion market capitalization.
Its massive size gives the company strong margins, and its aggressive merger & acquisition strategy presents significant cost synergies.
Another competitive advantage for Walgreens Boots Alliance is its strong brand name. There are thousands of Walgreens stores around the country, many of which are smaller stores that generate high walk-in traffic.
This keeps customer retention and brand awareness high.
Walgreens Boots Alliance enjoys a recession-resistant business model. Consumers need to pay for prescriptions and other health care products if they are sick or injured. This helps the company stay profitable, even during recessions.
Walgreens Boots Alliance held steadily profitable throughout the Great Recession of 2007-2009:
- 2007 Earnings-per-share of $2.03
- 2008 Earnings-per-share of $2.17 (new high)
- 2009 Earnings-per-share of $2.02 (7.2% decline, recession low)
- 2010 Earnings-per-share of $2.16 (6.9% increase)
- 2011 Earnings-per-share of $2.64 (22% increase, new post-recession high)
As you can see, Walgreens Boots Alliance’s earnings-per-share took a dip during the financial crisis. That being said, the company endured only a modest decline. And, it quickly recovered and emerged unscathed.
Valuation & Expected Total Return
Walgreens Boots Alliance trades for a price-to-earnings ratio of 21. The stock trades at a slight discount to the S&P 500 Index, which has an average price-to-earnings ratio of around 24.
However, since 2000, Walgreens Boots Alliance has traded for an average price-to-earnings ratio of 18.5. This indicates that the stock is at least fairly valued, if not slightly overvalued, based on its historical average.
As a result, there may not be much more room for expansion of the price-to-earnings ratio. That being said, the company should continue to generate earnings-per-share at a rapid pace.
Earnings-per-share could easily grow at least 10% per year moving forward. This growth would be achieved based on a combination of organic revenue growth, growth through acquisitions, cost cuts, and share repurchases.
Investors buying the stock at the current price may earn double-digit annualized returns going forward, based on the following factors:
- 10%-12% earnings-per-share growth
- 1.8% dividend yield
Under this scenario, total annual returns would reach ~12% to ~14% going forward.
Investors looking for exposure to the health care space typically look to pharmaceutical stocks. These are good choices, but investors should also look at Walgreens Boots Alliance.
The company has a well-defined growth trajectory up ahead. The business climate remains supportive of growth, particularly in the U.S.
In the overseas markets, Walgreens Boots Alliance is rapidly expanding its presence through acquisitions.
As such, the outlook for Walgreens Boots Alliance remains very positive.
One drawback to buying Walgreens Boots Alliance stock is its low dividend yield. The current dividend yield trails the average dividend yield in the S&P 500 by about 20 basis points.
That being said, Walgreens Boots Alliance has increased its dividend each year, going back four decades. Its long track record of annual dividend hikes, along with its high prospects for future dividend increases, makes Walgreens Boots Alliance a strong dividend growth stock. The company ranks in the top 20 using The 8 Rules of Dividend Investing.