Although Walgreens Boots Alliance (WBA 3.69%) reported stronger than expected Q2 results on April 2, the stock is down almost 30% in 2020 as investors are concerned that revenues will decline meaningfully in the second half of fiscal 2020 due to the COVID-19 pandemic. While it's difficult to forecast how much and how long the virus will hurt the company, U.S. sales should eventually stabilize and rebound.
More importantly, Walgreens' attractive dividend yield and its financial strength mitigate the risk of COVID-19 significantly disrupting its operations in the near-term. Here's why Walgreens investors should hang onto this healthcare stock.
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Second-quarter revenue boosted from initial COVID-19 shopping
The second-quarter results were better than expected due to higher U.S. revenues and better cost management. As a result, Walgreens was highly confident that it would meet its prior guidance for flat earnings growth in 2020. Further, the company continued to believe that it would deliver over $1.8 billion in annual cost savings by fiscal 2022 by renegotiating its contracts with its suppliers, closing stores, and streamlining its field organization. Lastly, Walgreens generated almost $1.8 billion in free cash flow for the first half of FY 2020, up from $0.4 billion in the same period a year ago, due to lower investment in working capital. The company used these proceeds to fund the payment of its dividend and the repurchase of its common stock.
On the conference call, the company also noted that U.S. retail comparable sales were up 26% during the first three weeks of March as customers stocked up on essential goods to prepare for stay-at-home orders and a widespread retail shutdown. Strong growth in the health and wellness, grocery, and other essential categories were only partially offset by a drop in discretionary categories such as beauty, photo, and seasonal items. U.S. retail same-store sales, however, only increased by about 14% for the full month as it was negatively impacted by a mid-teens decline in the last week of the month. The company anticipated continued weakness in April based on lower store visits and the overstocking of essential goods.
U.S. pharmacy revenues also increased during the first three weeks of March but then fell during the last week due to lower foot traffic and the fulfillment of prescriptions in the early part of the month instead of at the end of the month. Lastly, the company could not accurately estimate the financial impact of the coronavirus, suspending its earnings guidance for 2020.
Stabilization and eventual rebound in U.S. sales
U.S. sales, which account for over 76% of total sales, should eventually bottom and rebound for several reasons. First, customers will need to visit the store to refill their prescriptions and replenish essential goods that have been used in the past few weeks including toilet paper, paper towels, and other consumer staples.
Second, customers who are reluctant to shop in person can order goods online and pick them up outside of the store or have them delivered. The investment in online and mobile ordering, the expansion of drive-through windows, the partnership with Postmates, and other initiatives enable Walgreens to provide convenient alternatives to in-store shopping.
Third, enhanced unemployment benefits, the distribution of one-time stimulus checks, and the gradual reopening in several states should cushion some of the loss of income and jobs as a result of the nationwide shut-down of businesses. The cash influx could contribute to higher discretionary spending. Further, the vast majority of the company's sales come from prescriptions, health and wellness products, and other essential goods that are far more stable and resilient than these discretionary items.
At the end of April, Walgreens announced that it plans to open COVID-19 testing locations in all 50 states. Walgreens' new testing sites will use LabCorp (LH 1.02%) COVID-19 nasal swab diagnostic test to determine if an individual currently has the virus. LabCorp will also begin to offer antibody testing at more than 100 Walgreens' patient service center locations where it provides testing. Walgreens has already established 23 drive through COVID-19 testing 23 sites in 15 states. The expanded COVID-19 testing program should result in higher visits to its store, generating more revenue.
Attractive dividend yield
As investors wait for financial results to stabilize, they will benefit from receiving quarterly payments that equate to a 4.3% annual dividend yield, which is much higher than the 2.3% yield that they would obtain if they purchased an S&P 500 index fund. The company remains committed to its simple policy of increasing its dividend every year, which has occurred for the past 44 consecutive years. The company has expanded its financial resources to allow it to continue paying a dividend at the current level and to meet any unforeseen challenges.
Adequate financial resources
Walgreens has sufficient resources to withstand a deep and protracted recession unlike other retailers and healthcare service providers. In March, management began to prepare for what they called a "black swan" event. The company increased its cash position and preserved its financial flexibility through executing new credit agreements and adjusting existing credit agreements.
In the middle of April, Walgreens further enhanced its cash position by issuing $500 million of 3.2% notes due 2030 and $1 billion of 4.1% notes due 2050. The company benefited from a stronger corporate bond market and obtained favorable rates on these unsecured notes. S&P Global confirmed its BBB companywide rating despite anticipating a modest down-turn in the near-term. S&P felt that the company had a "more than decent" cushion to allow for a potential deterioration in its credit ratios.
Attractive opportunity relative to its competitors
Walgreens offers a more attractive investing opportunity compared to its two main competitors, Rite Aid (RAD 20.00%) and CVS Health (CVS 1.49%). Unlike Walgreens, Rite Aid does not pay a dividend and is not profitable. Further, Rite Aid has been negatively impacted by flat U.S. retail sales, high debt, and its small size.
While CVS is a larger and more diversified company and generates more free cash flow than Walgreens, its shares offer a lower dividend yield of slightly less than 3.3% and it has essentially stopped repurchasing its common stock since the end of 2017. CVS' operations are far more complex and involve greater risks and challenges relative to Walgreens' operations.
Long-term buy
At this point, patient long-term investors should consider purchasing shares of Walgreens. While revenue could meaningfully decline in the near-term and take time to recover, the stock has mostly discounted the bad news and offers a very attractive dividend yield.
Further, the majority of the company's sales come from consumable essential goods that will need to be replaced. Walgreens has adequate financial resources and the ability to issue additional debt at attractive rates to weather a long and severe economic storm. Investors looking for exposure to growth in pharmacy retail would do well to buy Walgreens' stock.
