In the last few years, I published several articles on Walgreens Boots Alliance, Inc. (NASDAQ:WBA) and similar to its competitor CVS Health I was always bullish in these articles. My last article about Walgreens Boots Alliance was published in January 2024, and I was bullish once again. And although I was not blind to the risks and mediocre performance in the recent past (especially the stock price performance was difficult to ignore), I still remained optimistic. In my last article, I wrote:
I would still argue that Walgreens Boots Alliance is too cheap to ignore. Walgreens Boots Alliance most likely does not have a wide economic moat around its business. It certainly has some competitive advantages – its huge size for example – making it not the easiest target for competition. But at this point, Walgreens Boots Alliance is much more vulnerable than its competitor CVS Health. And in the last few years we also see declining margins and low return on invested capital – underlining that WBA is rather in trouble.
But despite any optimism, the stock is falling lower and lower and recently Walgreens Boots Alliance hit a 25-year low. From its previous all-time high, the stock declined more than 83% and while looking at the performance of the last ten years, the S&P 500 (SPY) increased 178% while Walgreens Boots Alliance declined 78%. Competitor CVS Health Inc. (CVS) also performed terrible in the last ten years but lost only 20% (not including dividends).
In the following article, we will take another look at Walgreens Boots Alliance. We analyze how the transformation is progressing, look at the third quarter results and how to think about the stock as an investment now (with WBA trading about 35% lower compared to the time when my last article was published).
Quarterly Results
On Thursday, June 27, 2024, Walgreens Boots Alliance reported third quarter results and results were more or less solid. Sales increased from $35,415 million in Q3/23 to $36,351 million in Q3/24, resulting in 2.6% year-over-year growth. And in the same quarter last year, the company reported an operating loss of $477 million and this quarter the company could at least report an operating income of $111 million. Diluted earnings per share increased again from $0.14 in Q3/23 to $0.40 in Q3/24 – resulting in 186% YoY growth. Free cash flow also switched from a negative amount of $444 million to $334 million in positive free cash flow this quarter.
And at first, these results might look solid with high-growth rates, but we must keep in mind that we are comparing results to an extremely horrible quarter.
We can also look at the results the three segments are reporting. The most important segment is still U.S. Retail Pharmacy, as it generated the biggest part of revenue and is usually also responsible for the biggest part of operating income. In Q3/24, the segment generated $28,503 million in sales and this resulted in 2.3% YoY growth. And while the top line increased slightly, adjusted operating income for the segment declined 47.9% year-over-year from $962 million to $501 million.
The second major segment is the International segment. Sales for this segment also increased from $5,573 million in the same quarter last year to $5,727 million this quarter – resulting in 2.8% year-over-year top-line growth. But adjusted operating income declined 15.9% year-over-year to $175 million in Q2/24.
The third segment is the newest and most promising segment – U.S. Healthcare. But growth rates also started slowing down, and sales grew only 7.6% year-over-year to $2,125 million in Q3/24. And also adjusted EBITDA was positive again (the second quarter in a row), the segment still reported an operating loss of $220 million compared to an operating loss of $552 million in the same quarter last year.
Impairment Charge and Balance Sheet
Already during the last quarter, Walgreens Boots Alliance wrote off losses in its U.S. Healthcare segment. And during the previous earnings call, management also commented on the non-cash goodwill impairment, which had a huge impact on the segment results:
In February, we received a downward revised longer-term forecast from VillageMD management. Including the impact of closing approximately 160 clinics, inclusive of the 60 previously communicated, slower than expected trends in patient panel growth and multi-specialty productivity and recent changes in Medicare reimbursem*nt models. These impacts were partly offset by actions taken in an attempt to right-size the cost structure. Given this revised forecast, we performed an interim test of VillageMD reporting unit goodwill that resulted in a fair value below its carrying value. Accordingly, we recognized a $12.4 billion noncash goodwill impairment charge prior to the attribution of loss to non-controlling interests.
As a reminder, our share of VillageMD's net assets carrying value also included a $2 billion gain recognized on the equity interest owned by the company immediately prior to the acquisition of majority equity interest in VillageMD during the first quarter of fiscal ‘22. This goodwill write-off is noncash, and we do not believe it will have a significant impact on our financial position or our ability to invest across businesses going forward.
High hopes are still relying on this segment and so far, positive news are dominating with top line still growing with a high pace and the segment being on its way to sustainable profitability.
As a result of the impairment charge last quarter, we also see shifts and change on the balance sheet.
Half a year ago, on August 31, 2023, Walgreens Boots Alliance still had $28,187 million in goodwill on the balance sheet and on May 31, 2024, the company reported only $15,821 million in goodwill. And of course, cutting the goodwill in half is a good move for the balance sheet, but considering $82,985 million in total assets about 19% of all assets are still goodwill and this is not great.
When staying on the asset side, Walgreens Boots Alliance has only $703 million in cash and cash equivalents, and this could generate a liquidity problem. It is never good when a company has only very limited cash reserves but combined with a struggling business that is reporting negative earnings and especially negative free cash flow, we could quickly run into problems. This could lead to the company having to take on additional short-term debt. In the recent past, Walgreens Boots Alliance sold parts of its stake in Cencora Inc. (COR) and generated $400 million in additional cash, but this didn’t improve the liquidity situation much.
On the liabilities side, the company already has $1,506 million in short-term debt as well as $7,407 million in long-term debt. When comparing the total debt to the total equity of $15,257 million, we get a debt-equity-ratio of 0.58, which is certainly acceptable and no reason to worry. Additionally, we can compare the total debt to the operating income of the last four quarters, but with numbers being negative in the last few quarters, these numbers don’t make much sense.
When being optimistic we could assume a similar operating income as in previous years (between $4 billion and $6 billion) and in such a scenario the current debt level is not a problem. But I don’t know if we have reason to be so optimistic right now.
Summing up, the balance sheet is certainly not perfect, but also no reason to be really concerned. However, management must keep a close eye on liquidity and the cash and cash equivalents it has on its balance sheet.
Dividend
I already wrote in my last article about Walgreens Boots Alliance cutting the dividend:
Along with the first quarter results Walgreens Boots Alliance also announced it will cut the dividend to $0.25 per share – an almost 50% reduction compared to the previous dividend. Hence, after increasing the dividend for 47 years in a row and being close to becoming a dividend king, the company now lost its status as dividend aristocrat.
And as pointed out by another analyst, a second dividend cut could be coming. Considering the balance sheet and low cash reserves and a negative free cash flow the company is generating right now, it seems likely that Walgreens Boots Alliance must preserve further cash reserves and cut cash outflows – and one to cut outflows is by reducing or eliminating the dividend.
Right now, Walgreens Boots Alliance is paying a quarterly dividend of $0.25 and an annual dividend of $1.00 resulting in a dividend yield of 6.3% making the stock in theory very attractive for dividend investors. In this scenario, Walgreens Boots Alliance must pay $860 million in dividends annually.
If another dividend cut is coming probably depends on how much cash the company can generate in the next few quarters. I don’t want to make any predictions, but I certainly would not rule out a dividend cut.
Maybe I Was Wrong?
In my last article I argued that there still might be a glimmer of hope, but the picture is still looking grim and while we still can find reasons to hope, it seems to clash with reality in several different ways.
There are small signs pointing towards more (or at least continued troubles). In my last article, management was still expecting EPS to be in a range between $3.20 and $3.50. In the meantime, top guidance was narrowed and shifted towards the lower end of the previous guidance. But now management lowered guidance again and is expecting only $2.80 to $2.95 in adjusted earnings per share for fiscal 2024.
And while we could argue that quarterly results were solid, we also must acknowledge that earnings per share are fluctuating wildly in the last few quarters and free cash flow also got worse from quarter to quarter in the recent past.
Only revenue is still growing with a solid pace but when gross margin and operating margin are getting constantly lower a growing revenue is nice to have but not really helpful for the business.
In my last article I also mentioned the chart as reason to be bullish but while I thought in my last article that Walgreens Boots Alliance might be at a strong support level, we now must acknowledge that the stock broke that support level as well and seems on its way towards lower stock prices. And now – pre-market as I am writing this – WBA is trading another 15% lower already.
In my last article, I pointed out that Walgreens Boots Alliance might turn around, and we can still be optimistic. But it seems like Walgreens Boots Alliance can’t keep up with its competitor CVS Health, and the competition from Amazon is also increasing. It was recently reported that Amazon has expanded its RxPass subscription savings program under its Prime membership scheme to Medicare beneficiaries. The RxPass offers access to fast and free delivery of 60 eligible prescription medications for $5 a month. Of course, we have to point out that delivering 60 prescription medications is not much but will lead to additional pressure for Walgreens Boots Alliance.
Conclusion
Walgreens Boots Alliance is still extremely cheap, and it doesn’t make much sense to underline this again (see my previous articles). But the stock being extremely cheap is always based on one condition: We must assume that Walgreens Boots Alliance will manage its turnaround and return to previous performance levels and being profitable again.
As always, management is remaining optimistic:
To wrap up, we have hard work ahead of us in our journey to simplify and strengthen WBA, but we are encouraged by our progress. This team has a clear mandate to act with everything on the table to put our business on the right track. We are well-positioned to drive capital-efficient growth, rooted in our retail pharmacy footprint, and build out an asset light health services strategy to deliver care for communities and create value for partners. We've kicked off our strategic planning work. Over the next three to six months, this team is undergoing an in-depth analysis to determine the actions necessary to achieve what we believe will be the optimal portfolio with a focus on maximizing growth potential and generating cash flow. We are reviewing every business through a longer-term lens focused on strategic fit, synergy potential, financial upside, and new or complementary capabilities. We are taking a thoughtful approach, fueled by a sense of urgency to finding opportunities to unlock value or validate existing pathways.
In my last article, I mentioned that there might be a glimmer of hope after all. And I still think there is a glimmer of hope. Nevertheless, I trimmed my position recently and sold about half of my shares of WBA a few months ago. I will hold on to the other half for now, but my previously bullishness has rather been replaced by the feeling that I made a mistake regarding Walgreens Boots Alliance. Although the stock is extremely cheap at this point, I would remain cautious and better search for investments somewhere else.
Daniel Schönberger
My analysis is focused on high-quality companies, that can outperform the market over the long-run due to a competitive advantage (economic moat) and high levels of defensibility. Focused on European and North American companies, but without constraints regarding market capitalization (from large cap to small cap companies).My academic background is in sociology and I hold a Master’s Degree in Sociology (with main emphasis on organizational and economic sociology) and a Bachelor’s Degree in Sociology and History.I also write about investing, economy and similar topics on Medium: https://medium.com/@danielschonberger
Analyst’s Disclosure: I/we have a beneficial long position in the shares of CVS, WBA either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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