Walgreens Boots Alliance (WBA) has experienced a dramatic decline, with its stock plummeting to multi-decade lows. Now down about 65% year-to-date and trading at $8.77, the stock has reverted to levels not seen since 1996. This steep drop has left investors wondering whether it presents a compelling buying opportunity or a potential value trap. This is particularly true given that even after January’s dividend cut, Walgreens’ yield has ascended to a juicy 11.4% following the stock’s nosedive.
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Overall, I believe there are significant risks, but I don’t entirely dismiss the stock’s potential. Therefore, I’m neutral on it.
Let’s take a close look!
Walgreens’ Financial Struggles Persist Despite Revenue Growth
Before we delve into Walgreens’ financial state, here’s a quick description of the company’s operation: Walgreens is a global healthcare, pharmacy, and retail enterprise that operates in various markets, including the United States, the United Kingdom, Germany, and other international locations.
As stated, I am neutral on WBA stock as I don’t dismiss the company’s potential to shift its current decline. However, the most significant factor contributing to the investors’ bearish sentiment is its underlying financial struggles despite what seems to be a robust top line with solid revenue growth.
Essentially, as a pharmacy company, Walgreens enjoys stable and predictable cash flows as consumers consistently purchase medications and other essential items. This, along with the pricing power of these products, has allowed Walgreens to post steady revenue growth over time. Indeed, in its latest fiscal Q3 results, sales once again grew by 2.6% to $34.4 billion, setting a record for the period. However, persistent pressure on profitability has made these top-line gains feel less meaningful.
Specifically, the company’s gross margin continued to erode, standing at 17.8%, compared to 19.1% last year. The key issue driving this decline is Walgreens’ persistent struggles with razor-thin profit margins, particularly in its pharmacy business. Pharmacy revenues rose 4.4% in the U.S., but margin pressures from reimbursement challenges and a less favorable brand mix weighed heavily on profitability. Shrinkage due to higher theft at retail locations further exacerbated Walgreens’ challenges in the retail segment, where sales fell 4.0% year-over-year.
Walgreens’ Ongoing Profitability Issues
As a result of the challenges mentioned, Walgreens’ quarterly operating income was just $111 million, a significant drop from $395 million in Fiscal Q3 2023. Even when adjusting for one-time items like the considerable impairment charges and cost-saving initiatives, adjusted operating income still saw a 36.3% decline. This explains why adjusted earnings per share (EPS) fell by 36.6% to $0.63, compared to $1.00 last year.
On that front, CEO Tim Wentworth has acknowledged the difficulties but emphasized Walgreens’ strategy of optimizing its U.S. retail pharmacy operations and streamlining its healthcare portfolio. The company plans to close underperforming stores and is working to address ongoing profitability issues within its U.S. healthcare segment.
That said, I would urge you to moderate any overly bright expectations. While these measures may provide some relief, the turnaround will take time. Further, the current business environment remains highly challenging, leaving little maneuvering space for Walgreens’ management to take meaningful action rapidly.
Walgreens’ Debt Burden Remains a Major Risk
Another critical financial strain impacting Walgreens’ investment case is its heavily indebted balance sheet. The company reported nearly $33 billion in net debt. Interest expenses for the quarter amounted to $113 million or about 19% of the company’s free cash flow for the period. With declining margins and practically no free cash flow left to pay down debt, Walgreens seems to have no way to deleverage and improve its financial position.
Is Walgreens’ 11.4% Dividend Yield Sustainable?
With Walgreens’ stock trading at historically low levels, the dividend yield has soared to 11.4%, even after the company slashed its payout by 48% earlier this year. For income-focused investors, such a hefty yield might appear tempting. Still, I would argue against its sustainability.
The reason for the January dividend cut after 47 years of consecutive annual dividend increases was apparent: declining profitability and a lack of sufficient free cash flow to cover debt obligations and the previous dividend payout. Even after the cut, nothing has changed regarding these issues. With profit margins declining year-to-date, whether Walgreens can keep about $216 million per quarter in dividends is questionable.
Given that management will likely be forced to prioritize deleveraging, I believe the probability of another dividend cut or a complete suspension is very high. Hence, the seemingly massive dividend should not be trusted.
Is WBA Stock a Buy, According to Analysts?
Views on Walgreens Boots Alliance range among Wall Street analysts. The stock has gathered a Hold consensus rating based on two Buys, seven Holds, and three Sells assigned in the past three months. Also, at $13.67, the average WBA stock forecast implies 55.87% upside potential. Still, note that price targets deviate considerably.
Conclusion
In summary, while Walgreens’ steep decline and massive dividend yield might catch the eye of contrarian investors, the company’s underlying challenges urge caution. Weak margins, persistent profitability issues, and a heavy debt load pose significant risks to Walgreens’ ability to maintain its dividend. As such, I view the stock as a potential value trap. Nevertheless, the possibility that a dividend suspension could unlock sufficient cash flow for debt reduction leaves room for an improved investment outlook, prompting me to maintain a neutral stance on the stock.
