Six months ago, I updated drugstore chain Walgreens Boots Alliance (WBA) after the company announced it was selling its low-margin Alliance Bergen wholesale pharmaceutical business, recalls Jim Pearce, chief investment strategist at Investing Daily's Personal Finance.
The goal of the sale was to allow WBA to focus on improving its in-store performance and expanding online capabilities. Walgreens had become overextended and needed to narrow the scope of its operations.
The change in direction comes after several years of subpar performance. Since adding it to our portfolio in 2016, WBA has declined in price while the S&P 500 Index has doubled in value. The stock has done better recently, gaining 38% over the past year while the index was up 31%.
Apparently, the rate at which Walgreens was executing was not satisfactory to its board of directors and a new CEO has been installed; Roz Brewer, was hired away from retail juggernaut Starbucks (SBUX) to bring a fresh perspective to Walgreens’ management team.
Brewer was quick to put her personal stamp on the business. After concluding the company’s fiscal year on August 31, Brewer put her plan in motion six weeks later. On October 14, Walgreens issued a press release with the attention-getting headline, “Walgreens Boots Alliance Announces Transformational Consumer-Centric Healthcare Strategy to Fuel Long-Term Growth.”
This is the first time Walgreens has unequivocally committed itself to a clear change in strategic thinking. Until now, the company’s focus has been on managing its vast portfolio of stores in North America and Europe from a supply-side perspective. Going forward, the emphasis will be on using a demand-side approach to optimize the allocation of its assets to maximize profitability.
The company’s message to Wall Street is clear: Walgreens management team is no longer the gang that couldn’t shoot straight, and change is coming fast.
The timing of the new strategic plan’s release coincides with the start of a new fiscal year for Walgreens. On the same day the company announced its new strategic plan, it also released its fiscal 2021 Q4 and full-year results (ending August 31, 2021).
Those results were respectable, including a 29.5% gain in Q4 earnings per share (EPS) after adjusting for one-time costs associated with the pandemic and other special items. For the fiscal year, adjusted EPS increased 14.6% over the prior year.
Brewer already has made clear her intention to expand Walgreens’ online presence so it can better compete with e-tailing giant Amazon (AMZN). Also, the company has launched a new business segment, Walgreens Health, to coordinate the activities of its various business units.
To facilitate that process, Walgreens just spent $5.2 billion to more than double its equity stake in VillageMD to 63%. In addition, it will invest $330 million to acquire a majority equity position in CareCentrix, which provides in-home healthcare solutions. Walgreens has an option to purchase the remaining equity in the company in the future, which it presumably will do if the partnership is a success.
Walgreens’ business has been held back by poor strategic decision making that has impeded the company’s operating results, allowing arch-rival CVS Health (CVS) to gain market share at its expense. CVS is more than twice the size of WBA and must now be viewed as the clear front-runner in what was a dead heat only a few years ago.
Patience has its limits, but I’m willing to hang on to WBA a bit longer to see exactly how the company intends to make good on its promises. At the moment (and for good reason), Wall Street is waiting for Walgreens to prove that it really can deliver on its new promises.
At a recent share price of $48, WBA is valued at only 10 times forward earnings. I don’t expect that multiple to increase significantly, but I do expect Walgreens to improve its profit margin from 2% to closer to 3% over the next fiscal year. If it can do that, WBA could rally above $70 where it was trading less than three years ago.
Combined with a forward annual dividend yield of nearly 4%, WBA should appeal to income and growth investors alike. Walgreens remains a buy up to $62.
