Is Walgreens Stock A Buy After 30% Drop This Year?

Despite almost a 30% decline in Walgreens Boots Alliance’s stock (NASDAQ:WBA) since the beginning of this year, at the current price of $41 per share, we believe Walgreens has a significant upside. Why is that? The key is Walgreens’ stock is still about 40% lower than it was at the beginning of 2018, a little over 2 years ago. Our dashboard, Why Walgreens Stock Moved -39%?, provides the key numbers behind our thinking, and we explain more below.

Some of this decline over the last 2 years is justified by the roughly 14% decline seen in Walgreens’ net income margin from 4.7% in 2017 to 4.0% in 2019. However, earnings growth, on a per share basis was higher by 17%, driven by revenue growth of 16%, and massive share buy-backs. Specifically, the company has invested about $15 billion in repurchases since 2017, resulting in about 14% lower outstanding shares. For the six months period ending Feb 2020, the company spent another $3 billion in share repurchases. While there was a slight decline in margins, revenue and EPS growth were strong. So what explains the drop in stock price? It was primarily the company’s P/E ratio.

Walgreens’ P/E ratio plummeted from about 13x at the end of 2017 to under 10x recently. This can partly be attributed to lower margins as well as the company’s international retail business facing tough competition from online retailers. While Walgreens P/E is down to about 7x now, given the volatility of the current situation, there is a significant additional possible upside for Walgreens multiple when compared to levels seen in the past years – P/E of 13x at end of 2017, and 11x as recent as in late 2018.

So what’s the likely trigger and timing to this upside?

Walgreens is not immune to the current pandemic. The global spread of coronavirus has meant lower footfall in stores. Though Walgreens sells essential goods along with pharmacy, given the social distancing norms, and after an initial surge in demand for stocking up in the early phases of lockdowns, the retail sales are likely to be impacted in the near term. With a lower number of prescriptions issued due to deferment of elective surgeries and non-essential hospital visits, the pharmacy sales could also decline. Additionally, mail-order prescriptions aren’t great for Walgreens due to added shipping costs, and stiff competition with online retailers, such as Amazon’s Pill Pack. Given all these factors, we believe Walgreens fiscal Q3 results will confirm the hit to its revenue.

However, looking beyond 2020, the company’s focus on localized communities will likely be beneficial in the long-run. Walgreens’ “The Transformational Cost Management Program,” which aims at annual cost savings of $1.8 billion by 2022, is also on track, likely resulting in improved net margins going forward. Additionally, the company’s massive buybacks, and an attractive valuation could result in a potential upside for the stock, in our view.

Over the coming weeks, we expect continued improvement in demand and subdued growth in the number of new Covid-19 cases in the U.S. to buoy market expectations. Following the Fed stimulus — which helped calm markets — investors have been willing to “look through” the current weak period and take a longer-term view. With investors focusing their attention on 2021 results, the valuations vs historic valuations become important in the search for value.

While Walgreens is good buy after a 30% correction this year, CVS Health could see over 35% gains from the current levels, in our view.

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