Some degree of volatility and uncertainty is a given on Wall Street. However, with a number of predictive indicators and economic data points suggesting trouble may be brewing for the U.S. economy and stock market, playing a bit of defense can be a smart move.
One of the wisest investments to make during periods of heightened uncertainty is dividend stocks. Companies that pay a regular dividend to their shareholders are usually profitable on a recurring basis, can offer clear long-term growth outlooks, and have often demonstrated that they can successfully navigate uncertain climates. In addition, income stocks have a lengthy history of outperforming their peers that don't offer a payout over the long run.
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But even though dividend stocks are long-term outperformers, they're not all universally loved by Wall Street. One such income stock, pharmacy chain Walgreens Boots Alliance (WBA 0.57%), sports a nearly 9% yield, but is arguably as disliked as I can ever remember it, despite being near a 25-year low.
That said, Wall Street sentiment hasn't dissuaded me from quadrupling my stake in recent weeks.
Walgreens needs a wellness prescription
Make no mistake about it: Walgreens Boots Alliance has some issues to work through.
For instance, the company has cautioned that foot traffic into its stores, as well as consumer spending trends, have been weaker than anticipated. Part of the blame, if you want to call it that, is the worst of the COVID-19 pandemic being in the rearview mirror. With fewer patrons visiting Walgreens' stores for their vaccines and testing kits, sales growth has slowed, even with an above-average inflation rate as a tailwind.
To add to the above, skeptics are also concerned about new entrants into the pharmacy space. Dominant online retailer Amazon announced its entrance in the online pharmacy arena in late 2020, while billionaire Mark Cuban has launched a direct-to-consumer venture known as Cost Plus Drugs. The margins Walgreens generates from its pharmacy segment are notably juicier than its front-end retail sales. Any hit to the company's pharmacy segment could prove meaningful to its bottom line.
To make matters even more challenging, Rosalind Brewer stepped down as CEO of Walgreens after 2.5 years. Brewer was championed for her success as COO of Starbucks, but this experience in retail failed to translate to a business focused on healthcare solutions and wellness. The uncertainty associated with a CEO search can be a drag in itself on a company's shares.
The final factor weighing on Walgreens Boots Alliance's stock is its balance sheet. Prior to 2020, the company was primarily focused on horizontal expansion (i.e., increasing its physical store footprint), which steadily increased its long-term debt and operating lease obligations. Considering that interest rates have climbed at their fastest pace in four decades (which may lead to higher interest expenses), there's real worry that Walgreens' hefty debt load may lead to a reduction of its nearly 9% dividend yield.
Keep in mind, Walgreens is three years away from having increased its base annual payout for 50 consecutive years.
I've quadrupled my stake in Walgreens Boots Alliance -- here's why
There's no question that it's been challenging to be a Walgreens shareholder, with the company's stock just a stone's throw from a 25-year low. But as a long-term investor, five factors have coerced me to look past the poor near-term sentiment surrounding the stock.
To start with, I'm encouraged by Walgreens' efforts to trim the proverbial fat. The company shed more than $2 billion in operating expenses a full year ahead of schedule and now plans to reduce its aggregate annual operating expenses by $4.1 billion ($2.1 billion more than its original target).
It also sold its wholesale drug operations to Cencora (previously known as AmerisourceBergen), which allowed Walgreens to pay down some of its long-term debt. Though cost-cutting isn't a growth strategy, it will give Walgreens more breathing room and should modestly lift the company's operating margin.
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A second core catalyst for Walgreens is the willingness of its management team to invest in various digitization initiatives. Despite cutting spending as a whole, the company has revamped its supply chain and spent big bucks to improve its direct-to-consumer experience. While it continues to generate the bulk of its sales from its brick-and-mortar locations, online ordering is an easy way to sustain steady organic growth.
The third reason I've been willing to increase my stake in Walgreens by roughly 300% is the company's healthcare-services transformation. After years of expanding its physical footprint, Walgreens entered into a joint venture with, and became a majority investor in, VillageMD. The duo has opened more than 200 full-service health clinics co-located in Walgreens stores. The fact that these clinics are physician staffed is a differentiator that should attract repeat customers in major U.S. markets. Walgreens and VillageMD aim to open 1,000 of these full-service clinics by the end of 2027.
Considering the company's push into higher-margin healthcare services, I'm also highly encouraged by Walgreens' board signaling its intent to hire a CEO with a background in healthcare. Last week, Bloomberg News reported that Walgreens is considering Tim Wentworth as its next CEO. Wentworth retired in 2021 as the CEO of health insurer Cigna's Evernorth Health Services segment, which provides a variety of pharmacy and health-management solutions. Even if Wentworth isn't the hire, the simple fact that Walgreens' board is clear about its intention to hire someone with a tenured background in healthcare is a big step in the right direction.
WBA PE Ratio (Forward) data by YCharts.
Finally, there's Walgreens Boots Alliance's valuation, which makes a lot of sense for patient, value-oriented investors. Even after taking into account weaker consumer spending in the near term, potentially higher future interest expenses, and increased shrink (theft), Walgreens' forward price-to-earnings (P/E) ratio of less than 6 is the cheapest it's traded in at least a decade, if not its history as a publicly traded company.
Regardless of whether Walgreens sustains its nearly 9% payout is irrelevant to me at this point -- although I do enjoy reinvesting my dividends. With the puzzle pieces in place to generate sustained mid-single-digit sales growth and lift the company's operating margin by as early as 2025, a forward P/E of less than 6 is a screaming bargain.
