Justin Sullivan
Investors in Walgreens Boots Alliance (NASDAQ:WBA) haven’t had much success since my previous article in September, as I highlighted that WBA remains a company in transition. The company appointed a new permanent CEO in late October 2023, looking toward Tim Wentworth to help it recover from its malaise as WBA re-tested lows last seen in 1998.
WBA’s historic tumble hasn’t gone unnoticed by investors, as sellers forced an incredible roundtrip for WBA’s “diamond hands.” As a result, I believe even the most ardent WBA investors likely felt compelled to “sell now and ask questions later” as they witnessed it falling to a 25-year low.
Even though Walgreens is considered a consumer staples (XLP) stock, its no-moat retail business model has always faced substantial risks. Walgreens faced challenges in managing the growing pricing power of dominant pharmacy benefit managers or PBMs, which eroded its margins. Moreover, it lacks a similar scale in the retail business compared to Walmart (WMT). As a result, Walgreens’s free cash flow or FCF profitability was always under immense pressure if the underlying fundamentals of its business shifted out of its favor.
Management updated that investors should continue to expect headwinds in FY24 as Wentworth and his team work on optimizing the company’s cost structure and streamlining its healthcare segment for profitable growth. Accordingly, Walgreens expects adjusted EPS to fall within the range of $3.20 to $3.50 for a midpoint outlook of about $3.35. It represents a YoY decline of about 16% from FY23’s performance as Walgreens laps the impact of its post-COVID headwinds. In addition, management anticipates that consumer spending headwinds could continue, impacting the near-term recovery of its retail segment.
Despite that, Walgreens expects to realize $1B in cost savings for FY24 as management attempts to stage FY24 as the inflection point. Investors should also expect CapEx reduction amounting to about $600M, as Walgreens tempers its growth strategies in its healthcare segment to focus on more profitable opportunities.
As a result, management telegraphed its confidence about improving the profitability outlook for its US healthcare segment, expecting to “reach breakeven or near breakeven” on an adjusted EBITDA basis.
Revised analysts’ estimates are in line with Walgreens’s outlook. Wall Street expects the company to post an adjusted EPS of $3.34, just slightly below the company’s midpoint outlook. Therefore, the worst of Walgreens’s battering could be over if the new CEO and his team could find their footing to engineer the company’s revival. On an FCF basis, the company is expected to post improvement in 2024 before recovering further through 2025, with its margin reaching about 2.2%.
WBA Quant Grades (Seeking Alpha)
Despite that, investors must question whether that’s enough to entice them to add more exposure while WBA still hovers close to lows last seen in 2009. Value investors attracted to its “A” valuation grade must be cautious, given its growth grade of “F.” In other words, Walgreens posts a worst-in-class growth profile compared to its sector peers, suggesting a value trap proposition isn’t overstated.
Therefore, solely relying on a seemingly highly attractive valuation is likely not sufficient to justify an investment in WBA, notwithstanding your level of conviction. Its “D” momentum grade underscores the robust selling momentum in WBA as investors rotated out of the stock with conviction.
I assessed that WBA will likely remain in consolidation over the next few months, but don’t expect a steep recovery. The market will likely continue placing Walgreens in the penalty box as they assess the revamp under the new CEO and his team. Given WBA’s no-moat model, investors are urged to consider other higher-quality setups that don’t face similar execution risks.
Rating: Maintain Hold.
Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.
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