Walgreens’ Strategy: Lose $3 Billion In Retail To Gain $24 Billion In Pharmacy?

Walgreens Boots Alliance (NASDAQ:WBA) Retail segment, which sells non-prescription drugs, beauty, toiletries, and general merchandise, has seen revenues shrink steadily from $40.6 billion in 2016 to $38.8 billion in 2019 and we expect these revenues to shrink further in 2020 to around $37 billion. There are several factors behind the revenue decline. Like most brick-and-mortar retail businesses, Walgreens’ retail business has seen revenues shrink due to increased competition from online retailers. The situation is particularly bad for Walgreens in the U.K., where stiff competition from online retailers has forced it to shutter many stores over the years.

Things are likely to only get worse over the coming months as the coronavirus outbreak has forced people to stay indoors and rely primarily on online deliveries for essential products even as there has been a sharp reduction in discretionary spending. But then why is Walgreens’ still in the Retail business? Why doesn’t it focus only on its Pharmacy business which sells prescription drugs and has seen revenues increase $23.5 billion between 2016 and 2019? The reason for this is two-fold: Walgreens offers a one-stop-shop solution for its customers looking for medicines as well as most daily essentials. Hence, the integrated approach has indirectly helped the company’s Pharmacy business grow and has also ensured that Retail sales don’t shrink at a potentially faster rate from the proliferation of online e-commerce companies. As Walgreens already manages the logistics related to keeping its 14,000+ stores stocked, the incremental costs linked with maintaining an inventory of general merchandise is quite low. The current model, hence, helps boost the company’s overall profit margins.

Even though the revenue share of Walgreens’ Retail segment has shrunk from almost 34% in 2016 to below 28% in 2019, and will continue to shrink over coming years, we believe that it remains an important part of the company’s business model as we detail in our interactive dashboard, Walgreens Revenues: How Does WBA Make Money? 

Walgreens Company Overview

Walgreens Boots Alliance operates a network of around 14,000 retail pharmacy stores globally, and it sells pharmacy and retail consumer healthcare products. The company sells both prescription and non-prescription drugs through its retail stores. Further, it also provides pharmacy services like prescription fulfillment through mail order, telephone, and Internet. Walgreens’ Pharmacy segment has been key to the growth in the company’s stock price over recent years. We discuss Walgreens’ Valuation analysis in full, separately.

A Quick Overview of Walgreens Revenues

Walgreens reported $137 billion in Total Revenues for full-year 2019. This includes 3 operating segments:

1. Pharmacy with revenue of $77 billion or 55% of the total revenue in 2019.
2. Retail with gross revenue of $39 billion or 28% of total revenue.
3. Wholesale with gross revenue of $23 billion or 17% of total revenue.

Walgreens’ Retail Segment Will Continue To Face Pressure Due To Softness In UK Business

• Retail segment, which includes the company’s retail sales of prescription drugs, and consumer healthcare products, saw sales decline from $40 billion in 2016 to $39 billion in 2019, and it will likely decline to less than $38 billion in 2022.
• This can be attributed to the company’s UK business, which is facing increased competition from online retailers. As such, the company could close some of its stores in UK.
• Though the situation is better in the U.S., and no. of stores in the U.S. have increased from 8,175 to 9,285 between 2016 and 2019, while average area per store has declined from 10.9k to 9.6k square feet. Revenue per square foot has remained stable around $308.
• International stores declined slightly from 4,673 to 4,605 between 2016 and 2019, and average revenue per store also declined from $2.8 million to $2.5 million.

But It Has A Role To Play In Walgreens’ Pharmacy Business With Revenues Increasing An Estimated 14% Over The Next 3 Years

• Pharmacy segment revenues have grown from $56.5 billion in 2016 to $77.1 billion in 2019, and it is estimated to be north of $88.0 billion in 2022, led by growth in the number of prescriptions as well as average revenue per prescription.
• A key factor behind the overall increase in the number of prescriptions is an increase in footfall across Walgreens stores, where the Retail offerings also play an important role.
• Also, the company added around 1,000 stores between fiscal 2016 and fiscal 2019 and is expected to continue to expand its network – further aiding revenue growth.

Conclusion
Additional details about how other components of Walgreens’ Revenues have changed over the years and are likely to trend going forward are available in our interactive dashboard. Trefis estimates Walgreens’ valuation of $53 per share, which is more than 35% higher than the current market price.

Walgreens compared to CVS Health is a better bet at the current price, in our view.

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