Here’s Why We Believe Walgreens Stock In Undervalued At $47

by Trefis Team
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Walgreens Boots Alliance
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The stock price of Walgreens Boots Alliance (NYSE:WBA) looks attractive at current levels of $47, as it is up a mere 7% from the levels it was on March 23, 2020, when broader markets made a bottom due to the spread of Covid-19. This marks a significant underperformance compared to the S&P which has moved 70% since its March 2020 lows, with the resumption of economic activities as lockdowns are gradually lifted and vaccination programs have been initiated in multiple countries. This underperformance can partly be attributed to investor concerns over Amazon’s entry into online pharmacy, that is likely to result in market share loss for pharmacies, such as Walgreens and CVS Health. WBA stock is also down 31% from levels of around $69 seen toward the end of 2018.

Some of the 31% decline of the last 2 years or so is justified, given the company’s lackluster fundamentals. Walgreens’ total revenue grew 6% to $139.5 billion in fiscal 2020 (fiscal ends in August), as compared to $131.5 billion in 2018. However, the company saw a decline in its net margins from 4.6% in 2018 to 3.0% in 2020, resulting in a 30% decline in net income from $6.0 billion in 2018 to $4.4 billion in 2020, on a non-GAAP basis. The company saw an 11% decline in total shares outstanding due to share buybacks, and on a per share basis, adjusted earnings declined 21% to $4.74 in 2020, as compared to $6.02 in 2018. Given the lackluster performance over the recent years, WBA’s P/E multiple also contracted, but it will likely see a rebound from the current levels. Our dashboard, ‘What Factors Drove -30% Change In Walgreens Stock between 2018 and now?‘, has the underlying numbers.

Walgreen’s P/E multiple contracted from 14x in 2017 to 8x in 2020 based on trailing non-GAAP EPS. While the company’s P/E is at 10x now, it can see an expansion in the near term, led by steady earnings growth. We discuss more in the section below.

So what’s the likely trigger and timing for upside?

Though Walgreens managed to grow its revenue in fiscal 2020, its business was also impacted during the pandemic. The global spread of coronavirus has meant more people staying at home, implying lower footfall at its stores. On the other hand, Walgreens along with other pharmacies, has seen a sharp increase in home delivery orders, though that business is subject to added shipping costs, implying lower margins. The company’s UK business, which has been struggling to compete with online retailers that offered discounts, continued to be a drag on the company’s overall performance. Looking at the company’s Q1 fiscal 2021 results, its total revenue grew 6% to $36.3 billion, while its adjusted EPS was down 11% to $1.22, partly due to the increased costs during the pandemic impacting its overall margins.

Now, the company has benefited from Covid-19 testing, with roughly 3 million tests administered thus far, and now with the vaccination drive, Walgreens will likely see steady revenue growth in the near term. While WBA stock has been weighed down by Amazon’s entry into pharmacy, its impact is yet to be seen. For now, the company doesn’t expect much disruption, given only 10% of the U.S. prescriptions filled go through the mail-order. Lastly, the company’s decision to close many of its stores, under its store optimization program, especially in the UK, means that the margins will likely improve going forward. Keeping these factors in mind, we believe the company will likely see steady earnings growth over the coming years.

Walgreens will likely see an increase in footfall at its stores going forward, as the Covid-19 crisis winds down. That said, any further recovery in the economy and its timing hinge on the broader containment of the coronavirus spread. Our dashboard Trends In U.S. Covid-19 Cases provides an overview of how the pandemic has been spreading in the U.S. and contrasts with trends in Brazil and Russia. Looking at valuation, at the current price of $47, Walgreens is trading at under 10x its estimated adjusted EPS of around $4.85 in fiscal 2021, compared to levels of over 14x seen in 2017, and 11x seen in 2018, implying there is more room for growth for WBA stock.

While WBA stock may see higher levels, 2020 has created many pricing discontinuities which can offer attractive trading opportunities. For example, you’ll be surprised how counter-intuitive the stock valuation is for UnitedHealth vs Ingevity.

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