Thesis:

Walgreens Boots Alliance (WBA) represents a compelling opportunity to own a vastly undervalued Dow Jones company near all-time lows on virtually every metric, whose fundamentals are expected to have a massively positive inflection in the second half of FY23. Over the short-term, various factors are expected to result in around 29% year-over-year (YOY) earnings growth in the second half of FY23, which I expect will shift investor sentiment to positive, causing WBA to climb significantly. WBA’s strategy is to transition into a multi-channel technology-driven healthcare provider, which is expected to drive longer-term EPS growth in the low teens.  My current fair value estimate for WBA is $70, representing 95% upside, plus the 5.35% dividend which pays you to wait.

My longer-term thesis is that WBA is very well positioned with the scale and capability to be successful within its segments of the healthcare industry. Of all the industries I follow, healthcare is the one that is most suited to a multi-channel approach, because healthcare services often require a physical presence.  Many people also get sick suddenly and want to pick up medication and other convenience items at a store, because they need their medication immediately, and don't want to wait or pay for delivery. There is also a need in the market for a one-stop shop, where people could get all or most of their medical needs met, resulting in a better healthcare service model and lower costs for all participants. WBA is uniquely positioned to capitalize on these trends, and the aging of America, through its scale of over 8000 domestic pharmacy locations, bringing 90% of the country within five miles of one of the company’s stores. If WBA executes successfully, they should be able to transition into a one-stop-shop for most of our healthcare needs, resulting in significant EPS growth for the foreseeable future, a much higher valuation, and a better standard of care for many people.

Why the Opportunity Exists:

I think the primary reasons WBA is undervalued is due to the following factors: 1) WBA has been undergoing a transition under its new CEO Rosalind Brewer, which has resulted in declining FY23 earnings estimates, in exchange for much greater long-term growth. Further contributing to FY23 EPS declines, is the lumpiness of COVID vaccinations and increased operating costs associated with the virus. These constraining factors are all about to reverse, turning from headwinds into tailwinds in the back-half of FY23, driving second half EPS growth of around 29% year-over-year (YOY), which is among the highest growth rates in the company’s history. 2) The market has been worried about the size of a potential opioid settlement. However, a settlement has recently been reached which is easily manageable for WBA, and has almost eliminated any additional material opioid liability. 3) The market has been worried about WBA’s ability to successfully integrate its recent acquisitions and implement its strategy to become a multi-channel healthcare company. As described below, it seems that there is a high probability WBA will hit or beat their guidance of a back-half FY23 earnings inflection, which will cause investor worries to turn into excitement for the future. Even if WBA achieves near its guidance, I expect the stock to perform very well.   

Catalysts:

I expect the primary near-term catalyst to be the tremendous growth inflection, which is expected to occur in FY23. WBA is projected to flip the company’s YOY EPS trajectory from about -31% in the first half, to 29% in the back-half, with significant growth of 13-15% for the foreseeable future. If WBA could even get close to achieving its projections, the stock could increase to the higher end of historic valuation multiples. The specific second-half FY23 growth factors that are expected to drive the 29% earnings growth include the following; 1) 11.5% from lower COVID headwinds; 2) 18% from WBA’s Healthcare business as the company integrates its recent acquisitions, reduces spending and grows revenues; 3) 5% from international growth as Boots continues to recover from negative COVID comparisons; 4) 13% from a mechanical increase in the timing of reimbursements; 5) 14% from lower cost of goods sold due to timing and cost reductions; 6) 13% from US script volume recovery as the company extends hours to normal levels and hires more pharmacists. Many of these hires have recently been made or are in the on-boarding process; 6) -14.5% other expenses, which I assume are increased labor costs and investments in growth projects.

Another potential catalyst for WBA is the sale of its UK subsidiary, Boots. It has been rumored that Boots is for sale, but only for the right price. This subsidiary is a large portion of WBA, with 3,989 retail stores under the Boots, Benavides, and Ahumada brands in the United Kingdom. If the company received a good price for these assets, it could be very positive for the stock. To note, it appears that Goldman might be restricted on WBA because I have noticed they have stopped publishing on the name, which could be indicative that a deal is in the works. A longer-term catalyst which could be a part of a Boots sale is the potential for a large return of capital to shareholders through share-repurchase, and/or higher quarterly and/or a special dividends. I estimate WBA will generate about $8.6 billion in FCF from FY23-FY24 without a Boots sale, a large portion of which could be given back to shareholders. I also expect the company to use their cash to continue to make bolt-on acquisitions and investments to advance their strategy.

Valuation:

WBA is currently valued at near all-time lows on virtually every metric of value. WBA is currently valued at a P/E, EV/EBITDA and FCF yield on my FY23 and FY24 estimates (which are similar to consensus), of 8.1x / 7x / 12%, and 7.3x / 6.2x / 16%. These valuation levels are irrationally low for a leading healthcare company such as WBA. I could derive a significantly higher current value for WBA using virtually any methodology, but I will just keep it simple by using a relative P/E approach. WBA currently is valued at 53% P/E discount to the S&P 500, while over a long-term basis that discount has been as low as 5-10% at times when the company was perceived more positively. I think its reasonable to assume that over the next 12 months WBA’s P/E could rise to a 10% discount to the S&P which would equate to a price of about $70, or over a 95% increase from the current stock price, plus the 5.35% dividend for total return potential of 100%. Put another way, at $70, WBA would be valued at an FY24 P/E and FCF yield of 14x, and 8.3%, which seems reasonably for a growing leader in providing omni-channel pharmacy and healthcare solutions.

WBA also owns 34 million shares of AmerisourceBergen (ABC) which is currently worth $5.5 billion and is not fully factored into my valuation estimates. WBA has been selling down its position in ABC and using the proceeds to pay down debt and make strategic investments. WDC accounts for its ABC stake using the equity method, and ABC is valued at about double the valuation multiple of WDC. Therefore, WBA could distribute the ABC shares to WBA shareholders which would create about $3 of additional shareholder value.

Company Description:

According sections of WBA’s 10-k, “Walgreens Boots Alliance, Inc., is an integrated healthcare, pharmacy and retail leader serving millions of customers and patients every day, with a 170-year heritage… A trusted, global innovator in retail pharmacy with approximately 13,000 locations across the U.S., Europe and Latin America… The Company is reimagining local healthcare and well-being for all as part of its purpose – to create more joyful lives through better health. Through dispensing medicines, improving access to a wide range of health services, providing high quality health and beauty products and offering anytime, anywhere convenience across its digital platforms, the Company is shaping the future of healthcare. Walgreens Boots Alliance is the largest retail pharmacy, health and daily living destination across the United States (“U.S.”) and Europe with sales of $132.7 billion in fiscal 2022. Walgreens Boots Alliance has a presence in 9 countries and employs more than 325,000 people. In addition, Walgreens Boots Alliance is one of the world’s largest purchasers of prescription drugs and many other health and well-being products… The Company provides customers with convenient, omni-channel access through its portfolio of retail and business brands which includes Walgreens, Boots and Duane Reade as well as increasingly global health and beauty product brands, such as No7, NICE!, Soap & Glory, Finest Nutrition, Liz Earle, Botanics, Sleek MakeUP and YourGoodSkin. The Company's global brands portfolio is enhanced by its in-house product research and development capabilities… The Company is well positioned to expand customer offerings in existing markets and become a health and well-being partner of choice in emerging markets…

 Healthcare Strategy: The Company plans to become a leading provider of local clinical care services by leveraging its consumer-centric technology and pharmacy network to deliver value-based care. The Company also plans to continue to transform its core pharmacy and retail business. The Company’s goal is to provide better consumer experiences, improve health outcomes and lower costs. To advance its healthcare strategy, the Company made majority investments in Village Practice Management Company, LLC (“VillageMD”), Shields Health Solutions Parent, LLC (“Shields”) and CCX Next, LLC (“CareCentrix”) which it believes will strengthen its capabilities in primary care, post-acute care and home care. These majority-owned businesses and the Company’s organically grown healthcare business, Walgreens Health, make up the Company’s U.S. Healthcare segment. The U.S. Healthcare segment offers a technology-enabled care model powered by a nationally scaled, locally delivered healthcare platform, organically developed clinical programs and strategic collaboration with its majority-owned businesses, including VillageMD, Shields and CareCentrix.

Recent Transactions: Shields acquisition On October 29, 2021, the Company completed the acquisition of a majority interest in Shields. Pursuant to the terms and subject to the conditions set forth in the Securities Purchase Agreement, the Company purchased additional outstanding equity interests of Shields, increasing the Company’s total beneficial ownership in Shields’ outstanding equity interests from 25% to approximately 70%, for cash consideration of $969 million.

Walgreens Boots Alliance, Inc. operates as an integrated healthcare, pharmacy, and retailer in the United States (U.S.), the United Kingdom, Germany, and internationally. It operates through three segments: U.S. Retail Pharmacy, International, and U.S. Healthcare. The U.S. Retail Pharmacy segment sells prescription drugs and an assortment of retail products, including health, wellness, beauty, personal care, consumable, and general merchandise products through its retail drugstores. It also provides health and wellness, and specialty and home delivery pharmacy services. As of August 31, 2022, this segment operated 8,886 retail stores under the Walgreens and Duane Reade brands in the United States; and 3 specialty pharmacies. The International segment sells prescription drugs; and health and wellness, beauty, personal care, and other consumer products through its pharmacy-led health and beauty retail stores and optical practices, as well as through boots.com and an integrated mobile application. It also engages in pharmaceutical wholesaling and distribution business in Germany. As of August 31, 2022, this segment operated 3,989 retail stores under the Boots, Benavides, and Ahumada brands in the United Kingdom, Thailand, the Republic of Ireland, and Chile; and 543 optical practices, including 160 on a franchise basis. The U.S. Healthcare segment provides value-based primary care services; post-acute and home care management services; and clinical healthcare services. It also operates as a specialty pharmacy integrator and accelerator for hospitals. As of August 31, 2022, this segment operated 334 VillageMD clinics, including 146 co-located clinics, 124 standalone clinics, and 64 affiliate clinics. Walgreens Boots Alliance, Inc. was founded in 1901 and is based in Deerfield, Illinois.”

Risks:

There are several risks associated with WBA, but I feel most of them are more than reflected in the current price, creating an extremely favorable risk/reward. Some of the primary risks are as follows; 1) WBA is unsuccessful in implementing its strategy and hitting its guidance; 2) Potential negative healthcare and drug price regulation, although Im not aware of anything currently on the horizon; 3) On-line and other competition, although WBA seems very well positioned to gain share if they execute correctly.