To get ideas for new investments, investors can either look at recent outperformers to capture growth momentum, or recent underperformers in hopes of catching a turnaround.
Looking at the latter type, the worst-performing stock of the S&P 500 in the first half of 2024 is, literally, a household name.
This stock declined 54% through the first half. After that terrible performance, this company's dividend yield has grown to a whopping 9%, in spite of that payout having already been cut by 48% earlier this year. After the stock's thorough drubbing, this company trades at only 3.7 times this year's earnings guidance.
But does that make this beaten-down name a deep value stock? Or a value trap to avoid?
NASDAQ: WBA
Key Data Points
Walgreens Boots Alliance is in the doghouse
The stock in question is Walgreens Boots Alliance (WBA +0.00%), the parent company of several name brand retail pharmacies in the U.S., U.K., Germany, and other International countries, with private label retail pharmacy products, and stakes in healthcare companies such as VillageMD, a value-based primary care company, and others.
Currently, there aren't many things going right with any of Walgreens' segments. But the primary problem is its core pharmacy business, which generates about three-quarters of U.S. pharmacy retail segment sales, which itself generates about three-fourths of Walgreens' revenues, or about 56% of Walgreens' total revenue. In that business, the concentrated pharmacy benefit manager (PBM) industry is squeezing retail pharmacy reimbursements, which has become an industrywide problem.
That means although Walgreens is seeing growth on its top line in its U.S. pharmacies, the division's profits are plunging. Compounding the problem is that retail sales outside the pharmacy were down 2.3% last quarter, and the healthcare segment, which Walgreens bought into in 2020 and then 2021, is still unprofitable, spurring the company to take a massive write-down on these businesses this year.
The resulting lack of profitability has spurred the company to cut its dividend once and lower guidance twice already this year. But with the stock fairly washed out, could Walgreens turn around, making it a huge deep value opportunity? Or are the risks to much to bear?
Image source: Getty Images.
Reasons to buy Walgreens
1. The company is now profitable: While the Walgreens story seems pretty dour, there are some kernels of optimism. And at less than four times this years adjusted earnings guidance, Walgreens is still profitable, at least on an adjusted basis outside of write-downs and one-time legal expenses. That means it may have wiggle room to invest in the CEO's turnaround plan and continue to pay down debt.
2. It has a new CEO with a good background to solve the key problem: Walgreens' new CEO is Tim Wentworth, who just came on board last October. His appointment is good news because he was formerly the CEO of Express Scripts, one of the "big three" pharmacy benefit managers currently squeezing retail pharmacies on reimbursements. So, if any executive would know how to level the playing field with an adversarial supplier, it's likely an executive that used to head one of those suppliers.
For his part, Wentworth has suggested that Walgreens is currently in talks to switch to a "cost-plus" business model, in which retail pharmacies would get a guaranteed margin on whatever drugs they sell. While no agreement has been reached, on last quarter's conference call with analysts, Wentworth noted that discussions with the PBMs about new payment models were, "super encouraging."
3. The company has costs it can trim and assets it can sell: On that call, management also outlined a specific turnaround plan. These included shutting down or attempting to turn around the 25% of its stores that are underperforming, the potential sales of either Boots UK at a later date, and likely nearer-term sales of Walgreens' stakes in healthcare provider assets VillageMD, Summit Health, and CityMD. Furthermore, the company has already identified $1 billion of potential cost savings this year.
With some low-hanging fruit to cut costs and several different types of assets, Walgreens new CEO has lots of options to potentially boost profits and unlock value.
But there are 3 big reasons to remain cautious and on the sidelines
While there are some reasons Walgreens could actually be a winning turnaround, there are a few reasons investors may want to watch from the sidelines, too:
1. Its issues could take time to change: The pharmacy, PBM, and drug industries are large and complicated. Thus, any significant change to the status quo could be hard to accomplish, or at least highly time-consuming. For instance, Walgreens' contracts with PBMs probably wouldn't be able to be changed until 2025 at the earliest. Furthermore, it's not exactly a great time to sell assets, with interest rates higher than they were when Walgreens bought into the primary care space.
2. Debt plus opioid overhangs: While a turnaround could potentially lead to Walgreens being a multi-bagger from here, there is also a non-zero chance of a total loss on one's investment, due to the company's debt load and opioid settlement payment overhangs. As of last quarter, the company had roughly $9 billion in debt, along with another $5.9 billion in opioid litigation settlement payments that Walgreens will have to pay out over time. With these overhanging liabilities, Walgreens is definitely on the clock to get its profitability in order.
3. The unmentioned looming competitive threat: While Wentworth discussed the company's turnaround plan at length, what he didn't address was the prospect of coming online competition in the pharmacy space, most specifically from Amazon (AMZN +1.25%). While Amazon has been in the online pharmacy business since 2020, it really hadn't found its stride until recently. In March, Amazon expanded same-day pharmacy delivery to both New York and Los Angeles, with New York being a key market for Walgreens' Duane Reed pharmacies. Moreover, Amazon said it plans to open same-day delivery in over a dozen cities by year-end. Furthermore, Amazon even opened its first physical pharmacy location in California, although that location is right new to one of its fulfillment centers.
Online pharmacy deliveries have yet to really catch on, but if the same-day delivery breaks through the adoption barrier, it could be a significant threat to physical pharmacies.
Turnarounds don't always work
When turnarounds work, investors can make a lot of money. However, when they don't, that's a potential recipe for losing much or all of your investment. Walgreens' debt load and litigation expenses are too big for this investors' liking, especially with such large industry forces at work and the looming threat of Amazon. In this investor's opinion, investors should monitor Walgreens' turnaround efforts from the sidelines for now.
