Making Your Portfolio Recession-Proof: Walgreens Boots Alliance (NASDAQ:WBA)

The entrance to Walgreens Boots Alliance headquarters in Deerfield, Illinois, USA.

JHVEPhoto

When reading articles and analysis about Walgreens Boots Alliance, Inc. (NASDAQ:WBA) it seems like several investors are seeing the stock as a value trap right now. And when looking at the performance of the last few years, it is hard to argue otherwise. While competitor CVS Health (CVS) could finally break the downtrend, which lasted for several years and moved higher in the last few quarters, Walgreens Boots Alliance is still close to multi-year lows.

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WBA data by YCharts

But Mr. Market is seldom right, and especially great long-term buying opportunities are created when a solid fundamental business meets pessimistic sentiment. And in my opinion, Walgreens Boots Alliance is an example for a business that will perform solidly in the years to come, but investors seem to be extremely pessimistic. I have already been bullish in my last articles, and I remain bullish although past performance might indicate otherwise. And right now, I would also argue that Walgreens Boots Alliance is the perfect investment for an upcoming recession. But let’s start by looking at the last quarterly results.

Quarterly Results

Last quarterly results were not great – and the stock was punished right away. In the third quarter of fiscal 2022, Walgreens Boots Alliance reported sales of $32,597 million and compared to $34,030 million in sales in the same quarter last year this is a decline of 4.2% year-over-year. And not only revenue declined year-over-year; while Walgreens Boots Alliance could report an operating income of $1,134 million in the same quarter last year, it reported an operating loss of $320 million this quarter. And finally, diluted earnings per share declined from $1.38 in Q3/21 to $0.33 in Q3/22 – a decline of 76.1% YoY.

WBA is reporting mediocre quarterly results

WBA Q3/22 Presentation

When trying to identify reasons for declining revenue and earnings per share, we can find several. Operating income switched to an operating loss, largely due to a $683 million charge related to the opioid settlement with the State of Florida as well as higher costs related to the Transformational Cost Management Program. And the lower COVID-19 vaccinations also had a negative effect on the business, as vaccinations were extremely high in the same quarter last year (however, this was to be expected).

WBA is maintaining its guidance for fiscal 2022

WBA Q3/22 Presentation

And despite the rather mediocre results, Walgreens Boots Alliance is maintaining its full year guidance and is still expecting adjusted earnings per share to grow in the low single digits.

Exceeding Expectations

We must acknowledge that the sentiment around Walgreens Boots Alliance seems to be rather negative – this is reflected by the stock price, which is continuing its downtrend, as well as the extremely low valuation multiples Walgreens Boots Alliance is trading for (we will get to that).

WBA could beat revenue and EPS for eight quarters in a row

Walgreens Boots Alliance Earnings Expectations (Seeking Alpha)

But when looking at past quarterly results and analysts’ expectations, Walgreens Boots Alliance could beat expectations for revenue as well as earnings per share eight quarters in a row. And it is not untypical that companies exceed analysts’ expectations (most companies do), but this is a hint that analysts and investors might underestimate Walgreens Boots Alliance.

Recession

Not only might analysts continue to underestimate Walgreens Boots Alliance, but the company (and stock) might also be a good pick for the next potential recession. When looking at the stock performance in the last few decades, we can see that Walgreens Boots Alliance reacted to some recessions by declining about 50%, but we also see the stock hardly reacting at all to some other recessions.

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WBA data by YCharts

And even more important than the stock price performance is the fundamental performance during a recession. The stock might react in extreme ways, although it is not justified by the fundamental business. When looking at revenue in the last few decades, it is hard to identify recessions. The declining revenue in the last few years cannot really be associated with any recession, and in previous recessions, Walgreens Boots Alliance could keep revenue at least stable. Earnings per share reacted to recessions, but very moderately.

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WBA Revenue (TTM) data by YCharts

And for the next potential recession, we can assume that Walgreens Boots Alliance will perform well again. And considering that the stock price already declined 60% from its previous all-time high, I would see the downside potential very limited in case of a recession. Walgreens Boots Alliance is selling pharmaceuticals and healthcare products, which remain essential even in economic downturns. And most of its wellness products can also be described as rather essential products. All in all, Walgreens Boots Alliance should be considered a very recession-proof business.

Dividend

Walgreens Boots Alliance also raised the dividend again. And while this can also be seen as a bullish argument, we also have to point out that the annual dividend was raised only by one cent – a dividend increase of only 0.5%.

Nevertheless, Walgreens Boots Alliance is interesting for its dividend. Not only has the company been a stable dividend payer, but the stock has a tempting 4.8% dividend yield right now. And such a high dividend yield should be interesting in a financial world where yields are still rather low. Walgreens Boots Alliance is also one of the dividend aristocrats and is on its way to becoming one of the dividend kings in a few years.

Acquisitions and Divestitures

When looking at Walgreens Boots Alliance right now, we also must talk about divestitures and acquisitions (although some of it might only be rumors right now). It is not a rumor that Walgreens Boots Alliance abandoned the sale of its Boots drugstore chain at the end of June. Walgreens Boots Alliance and the consortium between Reliance Industries Ltd. and Apollo Global Management Inc. could not agree on the price for the UK drugstore chain. While WBA was expecting to achieve about $6 billion from the sale, the consortium was obviously not willing to pay that amount.

And aside from divestitures, Walgreens Boots Alliance is also affected by acquisitions. Amazon.com, Inc. (AMZN) agreed to acquire One Medical (ONEM), and the news had a negative effect on the share price of CVS as well as WBA. This was especially bad news for CVS Health as the company was also interested in acquiring One Medical. And while I still don’t think that neither CVS nor WBA must be afraid of Amazon, it is showing that Amazon is continuously moving in the healthcare and pharmaceutical distribution sector.

Additionally, there was some speculation about a potential acquisition of Teladoc Health, Inc. (TDOC) by CVS Health or Walgreens Boots Alliance. And while Teladoc Health could be a fit for CVS or WBA, I don’t know if an acquisition would be a smart move, as both companies should be able to duplicate the service for themselves as Teladoc must rather be seen as a business without a moat.

Growth

And growing by acquisitions or strategic investments in other businesses is certainly one way to grow for Walgreens Boots Alliance. In my last article, I already mentioned the investments in VillageMD as well as Shields. Both are part of the new Walgreens Health growth strategy.

Walgreens Health strategy is working with VillageMD and Shields

WBA Q3/22 Presentation

And Walgreens Boots Alliance has quite ambitious goals for Walgreens Health in the next few years. Until 2027, the company is expecting to have about 1,200 Walgreens Health Corners as well as 1,000 co-located Clinics with VillageMD. In total, Walgreens Boots Alliance is expecting $9-10 billion in sales from its Walgreens Health segment.

Walgreens Health has ambitious long-term targets

WBA JPM Healthcare Conference Presentation

However, we must point out that Walgreens Health is not able to meet its previous sales goals. During the Investor Day last year, the company expected about $3 billion in sales in 2022, at the beginning of the year it was lowered to $2.6 billion and now WBA is expecting only $2 billion in sales.

Walgreens Health Key Metrics

WBA Q3/22 Presentation

Nevertheless, the growth numbers are still solid and sales as well as locations are growing with a high pace. So far, the company has opened 56 Health Corners and is on track to reach its calendar year 2022 goal of 100 Health Corners. It also has 120 VillageMD co-located clinics and is on track to reach 200 till the end of the current calendar year. Recently, Walgreens Boots Alliance also announced a strategic partnership with Buckeye Health Plan – the third partner (either payor or provider) and wants to reach 5 till the end of the year. Pro forma sales growth for VillageMD was 69% year-over-year, and Shields grew 47% year-over-year.

Large addressable market

WBA JPM Healthcare Conference Presentation

And Walgreens Boots Alliance sees a huge addressable market for VillageMD. In optimistic expectations, the company sees a total addressable market of $3.3 trillion in 2025.

Intrinsic Value Calculation

While several others might consider Walgreens Boots Alliance as a value trap – that is deserving its low valuation multiple – I consider WBA as extremely cheap. Never mind what the perspective is – the facts are obvious. And a fact is that WBA is trading for a P/E ratio of 6.4, which is extremely close to the lowest P/E ratio of the last ten years and an absurdly low valuation multiple for a solid (growing) business.

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WBA PE Ratio data by YCharts

And instead of calculating an intrinsic value once again, we can look at my calculation in January 2022 as the numbers are still accurate. In my last article, I wrote:

Instead of looking at the simple valuation metrics, we can also use a discount cash flow calculation to determine an intrinsic value for Walgreens Boots Alliance. As basis for our calculation, we can use the free cash flow of the last four quarters, which was $4,057 million. When assuming that Walgreens Boots Alliance is not able to grow at all, the intrinsic value for Walgreens Boots Alliance would still be $46.76 (assuming a 10% discount rate and 867.6 million outstanding shares). When assuming a modest growth rate of only 3% for the years to come, the intrinsic value would increase to $66.80, and Walgreens Boots Alliance would already be undervalued.

But we can make several arguments, that an intrinsic value of $66.80 is still not accurate for Walgreens Boots Alliance. First, when looking at the average free cash flow of the last five years, it was much higher than the free cash flow of the last four quarters. And when using that amount ($4,995 million) as basis instead and assume once again 3% growth till perpetuity, we get an intrinsic value of $82.25 for Walgreens Boots Alliance.

When looking at the growth assumptions and management’s long-term guidance from above, we still must state that these assumptions are too cautious. An assumption of only 3% growth till perpetuity is also too cautious when looking at past growth rates of Walgreens Boots Alliance. When calculating with the assumptions from Walgreens Boots Alliance long-term growth algorithm (0% growth in 2022, about 4% growth in 2023 and about 7% growth in 2024 and 11% growth from 2025 going forward) we get an intrinsic value of $136.78 for the stock. And I still used the lower free cash flow of the last four quarters and of course only 6% growth till perpetuity starting a decade from now (as I always do).”

WBA is expecting double-digit EPS growth over the long run

WBA Investor Day Presentation 2021

Conclusion

In my opinion, Walgreens Boots Alliance is a solid business, which should also be able to grow with a solid pace in the years to come. Additionally, we are talking about a business that is recession-proof – an aspect that might be extremely important in the next few years. And while others might argue Walgreens Boots Alliance is a value trap that is deserving a low-to-mid single-digit valuation multiple, I consider the stock a great investment at this point.

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