Since I last wrote about the big pharmacy chain Walgreens Boots Alliance (NASDAQ:WBA) in January, its price has fallen by a significant 21% and even more year-to-date [YTD]. The writing was on the wall even at the time, which led me to title the article “Walgreens: The Dividend Cut Is The Final Nail” and put a Sell rating on it.
The impetus for the title followed a 48% dividend cut in the first quarter (Q1 FY24, quarter ending February 2024) following a change in leadership, as Tim Wentworth, took the helm. The company’s dividends have been the stock’s unique selling point in the past three years, with its price trending downwards for much of the time.
The dividend cut followed weak earnings. Not only did Walgreens clock a GAAP loss in Q1 FY24, its non-GAAP earnings per share [EPS] at constant exchange rates also declined by 43.7%. Further, for the full year FY24, the company forecasts another 16% adjusted EPS decline. In other words, the dividend outlook didn’t look like it would improve anytime soon, either.
Despite this, though, three months later, the stock looks somewhat better placed. Here are three reasons why it could see an uptick in the foreseeable future:
Non-GAAP earnings show upside surprise
The first point to note is that the company’s non-GAAP earnings per share [EPS] increased by a small 3.4% in Q2 FY24. Even though the increase isn’t significant, the fact that it has occurred at all is a welcome change. Not only had the number declined sharply in Q1 FY24, it was down by 21% in FY23 as well.
On a GAAP basis, Walgreens continued to pose a loss (see table below) on account of a non-cash impairment charge related to VillageMD, the primary care provider in which Walgreens owns a 63% share. Disappointing as this is, the fact remains that Walgreens would have actually reported a minor net profit if it weren't for the charge. It also indicates that once this hurdle is overcome, the company’s positive earnings can resume, which is also expected by analysts as per estimates for FY25 available on Seeking Alpha.
Market multiples are low from a historical standpoint
This brings me to the next point. For FY25, analysts expect a small turnaround in non-GAAP EPS. With this estimate, the stock’s forward non-GAAP price-to-earnings (P/E) ratio is at just 5.87x, which compares favourably with WBA's five-year average of 8.5x.
Given the small expected change in FY25, the ratio for FY24 isn’t terribly different either. At the midpoint of the company’s revised earnings guidance for the current financial year, the P/E is at 5.84x. Even if the EPS comes in at the lowest end of the guidance range, the forward P/E is still at 6x. This number is not just lower than the historical average, it’s also significantly lower than the 7.7x it was at when I last checked.
The gap between the five-year average and the current P/E has now become glaring enough to make a better case for the stock compared to the last time. At that time, a discount was justified considering its sharp dividend cut in Q1 FY24. But even going by the cut, the stock’s yield isn’t bad now, which brings me to the next point.
Forward dividend yield isn’t bad
The forward dividend yield is at 5.21%, which compares favourably with the median of 2.61% for the consumer staples sector. That it is much lower than the trailing twelve months [TTM] yield of 8.8% of course, but on its own, it’s not bad at all.
Further, with at least non-GAAP earnings growth to turn mildly positive from the next financial year onwards, there may not be any more dividend cuts going forward. And considering how much Walgreens’ price has fallen, there could be both capital and income gains in store for investors now.
The risks ahead
For all the improvements, however, the stock’s not out of the woods yet. For one, the company reduced the upper end of its non-GAAP EPS guidance range when it released its Q2 FY24 earnings report late last month. It now expects the figure to range between USD 3.2-3.35 compared with the earlier expectation of USD 3.2-3.5. The company attributes it to three reasons:
Challenging retail environment: Pharmacies have faced numerous challenges in recent years, including increased online purchases, higher labour costs and thefts at stores.
Sales leaseback: The company expects a winding down of the sales-leaseback programme, that resulted in Walgreens’ selling off multiple properties over the years.
Stake sale: Reduction in its stake in drug distributor Cencora to 13% from the earlier 15%, which reduced potential income from it.
I wouldn’t rule out the likelihood of an earnings slowdown, going by the company’s weak sales outlook as well. For FY24, it expects the revenue number to range between USD 141-145 billion. At the midpoint of the guidance range, this is a 2.8% year-on-year (YoY) increase. Even at best, it would be a 4.2% rise. Whichever way we look at it, growth would slow down from the 4.8% in FY23.
Further, at the midpoint of the range, the forecasts indicate a contraction in revenue by 2.25% in H2 FY24, which could be damaging for the stock’s fortunes as well, especially at a time when the momentum is against it already.
What next?
In sum, while the prospects for Walgreens have improved since I last checked, there are risks ahead too. On the plus side, the company’s non-GAAP EPS increase in Q2 FY24 is encouraging, as is the fact that earnings growth can turn positive from FY25 onwards. The sharp reduction in its forward P/E also makes it look more attractive, particularly as its forward dividend yield isn’t bad even after its dividend cut last quarter.
However, risks remain. This is most obvious in the company reducing the upper end of its EPS guidance range for FY24. This is particularly disappointing as its revenue is already slated to contract in H2 FY24. The likelihood of these factors continuing to cast a shadow on the share price can’t be ruled out.
On balance, though, Walgreens isn’t as badly placed as it was the last time I checked. It might not be a stock to buy today, but it's worth holding, if it’s already in the portfolio or if you are watching for improvements, given the possibility of an upside. I’m upgrading Walgreens to Hold.
