Walgreens Boot Stock: Risk/Reward Biased Up (NASDAQ: WBA)

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Thesis

Trading at a one-year forward P/E below x6 and a dividend yield above 5%, Walgreen Boots Alliance (NASDAQ: WBA) the stock is simply too attractive to ignore. Investors should consider that from a top-down perspective, there is little this raises doubts that WBA will not continue to deliver attractive cash flows in relation to the company’s valuation. Personally, I think WBA shares should be valued at $47.45/share. I anchor my argument on a residual earnings model based on consensus analyst estimates.

For reference, WBA has underperformed since the start of the year: this stock is down 33% against an 18% loss for the S&P 500 (SPY).

WBA vs. SPX YTD 2022

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About Walgreen Boots Alliance

Walgreens Boots Alliance, Inc. is the holding company that owns the Walgreens and Boots drugstore chains, as well as some smaller pharmaceutical manufacturers and distributors. WBA is best described as a pharmacy-led retail business, which sells both prescription drugs and a portfolio of retail products, including beauty, health and wellness verticals. be. The company was created in 2014, following the merger of Walgreens and Alliance Boots. This made the conglomerate one of the largest pharmaceutical distributors in the world. Today, WBA operates nearly 9,000 retail stores in the United States and just over 4,000 retail stores in Germany, the United Kingdom, Ireland, Norway, the Netherlands, Thailand, Mexico and Chile. Notably, at the start of 2022, Walgreens Boots Alliance was ranked 18th among American companies by revenue (Forbes 500), generating more than $132 billion in sales in 2021.

WBA Finances

From Walgreens and Alliance Boots merged in 2014, the company has been able to maintain a steady business expansion, revenue growth at a CAGR of around 5%. As a result, revenues have grown from around $103 billion in 2015 to $132.5 billion in 2021. To be fair, profitability hasn’t grown at a similar rate. During the same period, gross profit fell from $26.9 billion to $28 billion. Operating profit even decreased: from $$5.2 billion in 2015 to $3.7 billion in 2021.

The loss of profitability can arguably be explained by two factors: (1) a tougher competitive environment – primarily due to the entry into the market of large players in general retail via e-commerce, notably Amazon ( AMZN) and Walmart (WMT) – (2) and WBA’s own investments in digital expansion. But in my opinion, the market has more than discounted the loss of profitability and a tougher competitive environment, as WBA stock has depreciated over 60% since 2015. As a result, WBA is now priced at a value company of $63 billion, made up of $30 billion in market capitalization. and $33 billion in net debt. This, I argue, is attractive relative to operating cash flow equal to $5.1 billion (TTM benchmark).

Cheap valuation and attractive return

Walgreen Boots Alliance is rated very cheap. Investors should consider that WBA stock is trading at a one-year forward P/E of less than x6, a P/S of x0.2 and a P/B of around x1. Compared to the sector median, these multiples imply an undervaluation of 71%, 81% and 65% respectively. Admittedly, WBA operates with financial leverage, so company multiples might be more suitable for comparison. Nevertheless, an EV/EBIT of x13 and an EV/Sales of x0.5 indicate that WBA stock could be undervalued by 15% to 70% compared to its competitors.

Additionally, I would also like to highlight the dividend yield above 5% for WBA, compared to 2.5% for the sector. Even if an investor sees WBA’s dividend safety as unsustainable — given tougher competition and pressures on margins from inflation — dividends provide a good margin of safety before the yield falters. compresses to the median of the sector.

WBA Valuation

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Target Price Estimation

To estimate the implied fair price of a stock, I like to use the residual earnings model, which is based on the idea that a valuation should equal a company’s discounted future earnings after capital requirement.

With respect to my WBA assessment, I make the following assumptions:

  • To forecast EPS, I rely on analyst consensus forecasts available on the Bloomberg Terminal through 2025. In my opinion, any estimate beyond 2025 is too speculative to be included in a valuation framework. But for 2-3 years, analyst consensus is usually pretty accurate.
  • To estimate the capital charge, I rely on WBA’s cost of equity at 10%.
  • To calculate WBA’s tax rate, I extrapolate the 3-year average effective tax rate from 2019, 2020, and 2021.
  • For the terminal growth rate after 2025, I apply 2.5%, which is equal to the estimated nominal world GDP growth.

Given these assumptions, I calculate a benchmark target price for WBA of $47.45/share (almost 35% upside).

WBA Valuation Residual Profit

Consensus of BPA analysts; Author’s calculation

Notably, my bullish price target does not reflect a specific combination of growth and cost of capital. In fact, please find below a sensitivity analysis that supports different assumptions.

WBA Valuation Sensitivity Table

Consensus of BPA analysts; Author’s calculation

Reflecting on WBA’s valuation discount, I think it’s fair to say that Mr. Market rates WBA as a value trap, with little upside potential. However, while it’s certainly possible that WBA will grow at a CAGR in line with nominal GDP growth (in fact, that’s my baseline assumption), I think the company has some interesting margin expansion potential. . Investors may want to consider that WBA’s EBITDA margin is currently below 3.5%, compared to around 12% for the consumer staples sector median. For reference, if management could increase profitability (EBITDA) to 5% of sales, an additional net profit of $1 billion to $1.5 billion could certainly be possible. And with management closing underperforming stores, while pushing for a higher share of digital sales, a 150 basis point margin expansion isn’t far-fetched, in my view.

Risks

Walgreen Boots Alliance has net financial leverage of approximately 100% of the company’s market valuation. Therefore, I think it is fair to worry about monetary tightening and rising interest rates, which could lead to an increase in the cost of debt and a decline in profitability. As a result, WBA’s dividend yield could suffer a contraction.

Over a short to medium term time horizon, investors might also want to consider that the current macroeconomic environment for equities is not very favorable. The outlook for the global economy is biased towards a recession, in my view, which is reflected in the uncertainty in equity prices. And WBA’s equity shouldn’t be free of volatility.

Conclusion

The risk/reward opportunity for Walgreen Boots Alliance stocks is attractive, in my view. Investors might want to consider that WBA’s P/E, P/S and P/B multiples imply an undervaluation to the sector median of 71%, 81% and 65% respectively. This haircut should more than adequately balance any risk the company may face with respect to industry competition and macroeconomic/monetary policy uncertainty. Based on a residual earnings model, I think WBA should be valued at $47.45/share. To buy.

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