Walgreens: After Being Kicked Out of the Dow Jones Industrial Average, Is the Drugstore Stock a Buy?

After being officially replaced by tech titan Amazon (AMZN) in the elite Dow Jones Industrial Average ($DOWI) to start this week, the shares of Walgreens Boots Alliance (WBA) can't seem to catch a break from their freefall this year. Down by 17.8% already on a YTD basis, WBA stock is underperforming the broader equities market by a wide margin.

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Walgreens was originally added to the Dow back in 2018 as a replacement for one of the original constituents of the index, General Electric (GE). The end of its six-year run in the index comes on the heels of its dividend cut announced earlier this year, which confirmed WBA's exit from another exclusive club - the Dividend Aristocrats.

After all this negative news flow, is the drugstore stock due for a turnaround, or should investors give the former Dow member a miss? Let's find out whether WBA is a potential bargain buy or a value trap at current levels.

About Walgreens Stock

Founded in 2014, Walgreens Boots Alliance (WBA) was formed by the merger of UK-based Boots and U.S.-based Walgreens. Now based out of Deerfield, Ill., the company is one of the largest integrated healthcare, pharmacy, and retailers in the world, with over 12,500 locations across the U.S., Europe, and Latin America. Its offerings include prescription and over-the-counter medications, health and wellness products, beauty products, and various other convenience items. WBA's market cap currently stands at $18.3 billion.

So, what's behind the underperformance in WBA? Here are the key catalysts behind the downside, as well as the factors that could help fuel a turnaround - plus, a look at what Wall Street expects.

The Bear Case for WBA

Declining Earnings: A key concern for Walgreens is consistently declining earnings. In the latest quarter, revenues grew by 10% from the previous year to $36.7 billion - but EPS fell by a steep 43.1% year-over-year to $0.66

In fact, over the past 16 quarters, the company has reported year-over-year EPS declines on 11 occasions, reflecting the WBA's inability to manage costs efficiently.

At the same time, the company's healthcare business continues to remain unprofitable, with gross margins negatively impacted as pharmacy reimbursement levels remain under pressure.

Massive Debt & Low Cash: The company's huge debt load and low cash levels are a major concern that likely drove the historic decision to cut WBA's dividend.

The company carries total debt of $9.3 billion, which towers over its cash balance of a mere $784 million. This huge mismatch between the debt and cash levels makes it vulnerable to liquidity problems, at best, and risks it solvency position, at worst.

Inflationary Headwinds: While the pace of inflation has slowed, prices are still rising at a faster pace than the Fed would prefer. That's negatively impacting consumer goods companies, including Walgreens. Price-conscious consumers are increasingly seeking value, and while pharmacies provide convenience, their prices often exceed those of general merchandise retailers.

The Bull Case for WBA

Valuation: The stark decline in Walgreens stock has left it attractively valued at current levels. WBA trades at 6.50x forward adjusted EPS, 0.13x forward sales, and 0.84x book - all of which represent a discount not only to the consumer staples sector median, but WBA's own historical five-year average valuations.

Given that, the risk-reward ratio appears to be attractive for a well-established company like Walgreens, which has a wide footprint and brand recognition among consumers.

Dividend Yield: Despite the 48% dividend cut, Walgreens stock still offers a dividend yield of 4.70%, which is well above the sector median. While the move ends WBA's run as a Dividend Aristocrat, it's a much-needed move to save cash, and expected to result in savings of about $800 million on an annual basis.

"This action will free up capital to invest in driving sustainable growth in the pharmacy and healthcare businesses, as well as paying down debt," said CEO Tim Wentworth on the fiscal Q1 earnings call.

Asset Sales: The company is making other strategic moves to become free cash flow positive again, too. In February, the company sold additional shares worth $934 million of Cencora (COR), the drug distributor in which it has now trimmed its ownership to about 13%. Cencora still remains a major supplier of pharmaceuticals to WBA's pharmacies.

And in late January, news reports emerged that the company is looking to sell its specialty pharmacy business, Shields Health Solutions. A Bloomberg report said that Walgreens is seeking about $4 billion for the business.

Finally, another report claimed that Walgreens is set to revive talks to sell its Boots chain of pharmacy stores in the UK for 7 billion pounds.

What Does Wall Street Say About WBA?

Taking all of this into account, analysts have deemed Walgreens stock a “Hold,” with a mean target price of $25.11. This indicates an upside potential of about 17.6% from current levels. Out of 15 analysts covering the stock, 2 have a “Strong Buy,” 10 have a “Hold,” 1 has a “Moderate Sell,” and 2 have a “Strong Sell” rating.

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On the date of publication, Pathikrit Bose did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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