Ben Reynolds' Top Dividend Aristocrats: Part 2

Pharmacy retail giant Walgreens Boots Alliance (WBA) ranks among our current favorite Dividend Aristocrats, notes Ben Reynolds, income expert and editor of the industry-leading advisor service, Sure Dividend.

Pharmacy retail giant Walgreens Boots Alliance (WBA) is dealing with multiple challenges right now, including rising competitive threats, and a weak overall business environment for brick-and-mortar retailers. And yet, it remains a highly profitable company with a universally recognized brand.

Walgreens Boots Alliance’s competitive advantages and steady growth over the years — even in hard times — have allowed the company to raise its dividend for 44 consecutive years, placing it on the list of Dividend Aristocrats.

We believe Walgreens Boots Alliance has multiple catalysts for continued growth, including investments in new partnerships, and an aggressive cost-cutting plan.

While the company invests in its turnaround, the recent downturn has reduced the stock valuation, and at the same time increased the dividend yield to over 3%. As a result, value and dividend growth investors could view this Dividend Aristocrat as a buy.

Business Overview

Walgreens Boots Alliance is pharmacy retail giant, with over 18,000 stores in 11 countries around the world. It also has a global pharmaceutical wholesale and distribution networks, that deliver to upwards of 230,000 pharmacies, doctors, health centers and hospitals each year.

In all, Walgreens Boots Alliance has a presence in more than 25 countries, annual sales in excess of $136 billion, and a market capitalization above $52 billion.

The current environment is highly challenging for Walgreens Boots Alliance. The broader retail industry is being impacted by declining mall traffic and intensifying competition from e-commerce retailers such as Amazon (AMZN) and others.

As a result, brick-and-mortar retailers such as Walgreens Boots Alliance have had to invest greater amounts in order to fend off competitive threats.

Last year, Amazon acquired online pharmacy PillPack for $753 million which was widely viewed as a precursor to a much bigger move into the pharmacy business. Walgreens Boots Alliance stock remains lower today than it was before Amazon announced the PillPack acquisition.

Walgreens Boots Alliance is investing in its own turnaround efforts, which has weighed on its profit margins. Fortunately, the company continues to generate healthy sales growth.

On October 28th, Walgreens reported fourth-quarter and fiscal year 2019 results. For the fiscal fourth quarter, sales increased 1.5% to $34.0 billion, led by a 2.1% increase in the Retail Pharmacy USA segment and a 3.1% increase in the Pharmaceutical Wholesale segment.

Higher expenses resulted in a 3.7% decline in adjusted earnings-per-share for the quarter. For the fiscal year, revenue increased 4.1% to $136.9 billion, while adjusted earnings-per-share decreased 0.5% to $5.99.

Investing For A Succesful Turnaround

These conditions are set to continue for at least another year. Along with its results for the concluded fiscal year, Walgreens Boots Alliance also provided an initial fiscal 2020 outlook. The company expects roughly flat adjusted earnings-per-share for the upcoming fiscal year, plus or minus 3%.

Sales are likely to continue growing, as Walgreens Boots Alliance benefits from a significant trend — the aging U.S. population. The large Baby Boomer generation means demand for health care products and services are likely to continue growing for many years.

Walgreens Boots Alliance has also implemented multiple initiatives to retain its competitive advantages. First, it launched an aggressive cost-cutting program, and recently increased its targeted annual savings from the program to in excess of $1.8 billion, by fiscal 2022.

It is optimizing its store portfolio to help meet its cost-cutting objective. For example, the company already announced it will close 200 Boots stores in the U.K., and another 200 U.S. stores.

Walgreens Boots Alliance is also investing in a number of strategic initiatives. A few examples of investments placed in fiscal 2019 include expansion of its store-in-store pilot program with Kroger Co. (KR), announcing plans for 600 LabCorp patient service centers at Walgreens stores, and making an investment in specialty pharmacy provider Shields Health Solutions.

We believe that Walgreens Boots Alliance is likely to return to positive earnings-per-share growth in the near future, due to its strong business model.

The company enjoys a top brand and thousands of stores that provide close proximity to its customers. Walgreens Boots Alliance is a resilient company, even during recessions. Its diluted earnings-per-share declined by just 0.5% during the Great Recession of 2007-2009.

Lastly, share repurchases will help to boost earnings-per-share growth. Companies buy back their own stock to reduce the number of shares outstanding, which naturally increases earnings on a per-share basis.

Walgreens Boots Alliance utilized $10.46 billion on share repurchases in fiscal 2019. As a result, the company ended the most recent quarter with 8% fewer diluted shares outstanding than at the same point last year.

High Expected Returns For This Dividend Aristocrat

We believe a combination of earnings-per-share growth, dividends, and an expanding valuation multiple could result in high total returns over the next several years.

Specifically, we expect the company to increase its EPS by 5% per year through 2024. This will be achieved through revenue growth, margin stabilization, and the benefits of share buybacks. In addition, the stock has an attractive dividend yield of 3.1%.

The stock could also be undervalued. Walgreens Boots Alliance is expected to generate earnings-per-share of $5.99 in fiscal 2020.  Based on this, the stock has a forward price-to-earnings ratio of 9.7.  Shares are currently trading well below our fair value estimate of 12.0, meaning the stock is trading at a compelling valuation.

Expansion of the price-to-earnings ratio from 9.7 to 12.0 could add approximately 4.4% to the annual returns of the stock. In total, Walgreens Boots Alliance stock could generate annual returns of 12%-13% per year, a strong rate of return that makes the stock a buy for value and income investors.

A near-term catalyst for a meaningful return is the possibility that Walgreens Boots Alliance will be taken private. In early November, Reuters reported that the company has conducted talks with a number of large private equity firms, including KKR.

Analysts from JP Morgan recently calculated a go-private offer could reach $75 per share for Walgreens Boots Alliance stock. At that price, investors buying at the current level would earn a return of approximately 28%, not including any dividends received.

However, no formal announcements have been made, and it is always possible discussions could break down due to various uncertainties. Still, Walgreens Boots Alliance stock is attractive even if the company does not go private, due to its high dividend yield and strong expected returns over the next several years.

Final Thoughts

Walgreens Boots Alliance continues to invest in its turnaround efforts, including optimizing its store portfolio and fighting off competition from Amazon.

In the meantime, the company was approached with an offer to go private. While a go-private deal would likely result in a meaningful return for shareholders from the existing stock price, it is not guaranteed that a transaction will materialize.

Therefore, investors should continue to assess the company’s long-term future. Fortunately, its long-term prospects remain promising. We expect Walgreens Boots Alliance to generate positive earnings-per-share growth, which could result in a higher stock valuation as well.

In addition, Walgreens has a solid dividend yield above 3%, and a long history of annual dividend increases. As a result, we view Walgreens Boots Alliance as a high-quality Dividend Aristocrat to buy and hold over the long-term.