Earlier this year Walgreen Company (WBA -1.33%) was one of healthcare's top performing stocks, returning as much as 34% on the year as of the middle of June.
However, shares have since slid more than 20% after Walgreen announced it wouldn't seek to do a tax inversion once it completes its acquisition of U.K. pharmacy giant Alliance Boots.
Despite Walgreen's recent slide, shares are still up a respectable 6.7% year to date, but that's likely cold comfort to those who bought into the company this spring. So, let's take a closer look at Walgreen and see if its decision to avoid a tax inversion has created a good time to pick up shares in portfolios.
Source: Walgreen Company
First, a bit of background
Walgreen is one of the most familiar retailers in America. The company operates more than 8,600 locations, serving virtually every corner of the country. But it's not just the nation's biggest retail pharmacy chain (CVS and Rite Aid both operate fewer stores), it also runs infusion drug services facilities, specialty drug pharmacies, a mail order prescription business, and operates more than 700 in-store healthcare clinics.
Walgreen has built up its enviable footprint by being a savvy acquirer and as a result, the company's market share among retail pharmacies totals 19%.
But those deals may not prove to be nearly as transformative as Walgreen's decision to buy Alliance Boots.
Alliance Boots is a major international drug chain and drug distributor and following its acquisition, Walgreen will become a global pharmacy retailer operating about 11,000 stores and 370 distribution centers, good enough to make it the globe's biggest drug wholesale and distribution network.
Tough decision
In addition to significantly pumping up Walgreen's ability to negotiate favorable prices with drugmakers, the agreement to buy Alliance Boots also gave Walgreen an intriguing option to pursue a tax inversion to reduce its annual tax bill.
That's because Walgreen's effective tax rate was 37.1% in 2013, far above Alliance Boots 20% rate.
WAG Effective Tax Rate (Annual) data by YCharts
Just how big of a deal could Walgreen's tax inversion have been? Big, considering that the company's pre-tax earnings last quarter totaled $1.1 billion. Walgreen set aside $351 million in income tax provision last quarter, or roughly 32% of its pre-tax income. At 20%, it would have only set aside $220 million.
But when push came to shove, Walgreen's board decided that the distraction of dealing with IRS, regulator, and consumer scrutiny would be too much for it to deal with while integrating and building upon its new global footprint.
It was (probably) the right choice, but it still disappointed investors who were eagerly hoping for higher, shareholder friendly, post-inversion earnings per share.
Debating valuation
Interestingly, while shares have dropped in the wake of the announcement, investors may find that long term patience pays off.
That's because Walgreen's stock has become less expensive than it was just a few months ago. While the company is still historically a bit pricey on its forward price to earnings ratio, its current 18.67 level is far more attractive than the 21.25 level ahead of the company's anti-inversion announcement.
Similarly, while Walgreen's price to forward sales remains higher than it was between 2008 and 2012, at 0.77 it's below its pre-recession levels and down from 0.90 earlier this year.
WAG PS Ratio (Forward) data by YCharts
And investors with a penchant for dividend plays can also take heart in knowing that Walgreen's dividend yield has climbed to 2.2% from less than 1.7% prior to the company's decision. That means that investors will be paid a bit more while they wait for shares to recover.
And another thing
Valuation will only really make sense if Walgreen can continue to grow its business. However, it's hard to doubt the company given how successful its been in the past. Not only has it built itself up into a massive player with more than $70 billion in annual sales, but it's also fashioning itself into a one-stop shop for healthcare thanks to its Take Care in-store healthcare clinics. Those clinics are increasingly helping Walgreen capture foot traffic and script volume as health reform boosts the number of people with insurance and consumers seeks out more convenient care for bumps, bruises, and the flu. Given friendlier valuation, cost-saving synergies from its Alliance Boots deal, and the chances for growth thanks to its in-store clinics, I'm willing to give Walgreen the benefit of the doubt.
