Walgreens Boots Alliance: Simply Changing CEOs Won't Likely Solve The Company's Problems (2024)

There are nearly few ideas more tempting than investing in well-known companies or iconic brands that appear to be trading at a significant discount. Finding value is hard, and when previously strong-performing corporations sell off hard, often investors will try to find a way to convince themselves that the stock is undervaluing the brand of the company.

Walgreens Boots Alliance (NASDAQ:WBA) was one of the best-performing stocks in the market for some time. With the larger retail chains such as Walgreens and Rite Aid putting many smaller and independent pharmacies out of business in the nineties, these companies operated in a very favorable environment for a while.

Still, the operating environment for retail pharmacies has slowly deteriorated over the last decade, and this retailer has been one of the worst-performing stocks in the market since late 2015. The company has given investors a total return of negative 68% since 2015, while the S&P 500 (SPY) has offered investors a total return of nearly 190% during this same time frame.

I last wrote about Walgreens Boots Alliance in August of 2023, and I wanted to update my coverage since the stock has sold off nearly 40% and a new CEO has been hired since I initiated my analysis of the struggling retailer with a rating of sell. I am changing my rating of WBA today to a strong sell. Despite the recent change in management and the hiring of the new CEO in October of 2023, the company's business model remains structurally broken. There also increasing signs the macro economy is beginning to deteriorate. Walgreens Boots Alliance is not likely going to be able to reverse the margin compression seen because of rising labor costs, the impact of Pharmacy Benefit Managers lowering drug costs, and increased competition from other pharmacy chains and online businesses such as Amazon. While the company's last earnings report showed some positive minor signs that are likely only short-term trends, the stock still looks significantly overvalued using several metrics.

Walgreens Boots Alliance's recent earnings looked decent on the face, but the company's second-quarter earnings report had several warning signs showing the retailer continues to struggle with several negative secular trends in the industry. The company reported normalized earnings per share of $1.20 a share and revenue actual $37.05 billion. These numbers beat expectations of $.82 EPS normalized and revenue actual of $35.83 billion. Management also reported the profit increased by 6.3% across all segments, and same store sales traffic in the US pharmacy retail business increased by 8.7%. International same store sales increased by 3.4% on a year-to-year basis. The number of prescriptions written in the US rose by 2.6% on a year-to-year basis.

Despite some misleading numbers, management still lowered guidance. The company now expects to earn between $3.20-$3.35 for the full year, versus previous guidance of $3.20-$3.50 for 2024. The company also guided for just low single-digit growth in 2025, and management has frequently overestimated the core business's strength as well.

The reality is that WBA has not meaningfully grown revenues since 2018, when the company earned nearly $132.5 billion and $5.07 a share. The company continues to face pressure on margins as well.

Walgreens Boots Alliance continues to be challenged by increased labor costs, higher levels of competition, and lower drug prices. The company recently reported gross margins of 18.59%, which is at a 10-year low for the retailer.

Even though WBA recently acquired VillageMD and Summit Health, and the retailer now offers 1-day delivery for most prescriptions, the company is struggling to compete in the challenging current operating environment for multiple reasons that are not going to change by simply replacing the CEO. Tim Wentworth the new CEO who comes over from Express Scripts, is likely going to find the task of trying to reverse the long-standing and structural issues that WBA faces to be very challenging.

While Wentworth has pledged to try to change the way Walgreens works with Pharmaceutical companies using PBMs, the reality is that retailers such as WBA don't have any significant leverage with the drug companies. The retailers need to carry the main drugs in their stores to sell these products and get foot traffic from people who will also purchase other products at the company's retail locations. Both Trump and Biden have also made an effort to lower drug costs for the critically important older demographic that are amongst the most reliable voters, and new legislation or regulatory efforts aren't likely to take any action that could potentially lead to higher drug costs.

Retail pharmacists such as WBA simply don't have enough leverage to change the pricing model that is not working for the retail pharmacy business. There is a reason Wentworth has not articulated any specific plan to reformulate the flawed core business model of WBA. The retailer lacks the leverage to implement a major overhaul of the current sales structure.

Retail Pharmacists such as WBA are also likely to face increased competition from other companies and online retailers such as Amazon as well. While the online prescription business has only grown marginally over the last four years, nearly 42 percent of people have still purchased a prescription online, even though most still rely on in-store pharmacists right now. Companies such as Amazon that are already delivering groceries and other products are still better positioned than WBA for what eventually should be an increased move online for filling of prescriptions.

The retailer has also struggled with increased competition from companies such as Walmart (WMT) and Target (TGT), both corporations with their own pharmacies as well. Increased competition was one of the core reasons cited by the now insolvent company Rite Aid when the company declared bankruptcy last year. While the US is an aging population, with nearly 10,000 people turning 65 every day, increased competition and lower margins have more than offset the larger market for companies in the retail pharmacy business. WBA's store offerings are also not remotely competitive with the variety offered at Costco (COST), Walmart, Target, and other bigger retailers.

There is also a severe labor shortage in the pharmacy industry that is expected by industry experts to get worse moving forward as fewer people are entering this field, and many in this sector don't want to work in retail stores anyway. Experts report that 4 out of every 5 pharmacies is having trouble filling positions, there have also been multiple reports of pharmacies such as CVS overworking these individuals as well. This led to labor strikes at CVS and Walgreens last year.

All investment theses have risks, and while if the company's new acquisitions were able to successfully transform the company into more of a comprehensive health care provider that can offer unique products and services, the company could likely reverse some of the market share losses WBA has seen over the last several years. The company's Boots brand also continues to perform well overseas, and the changing demographics in the US are favorable for the pharmacy industry, with the higher percentage of the US population over the age of 65 now. If Wentworth can successfully renegotiate or find a way to modify the current flawed business structure that PBM's have created, that could reverse negative and longstanding trends facing WBA as well. The most important metrics for WBA are net margins, same store traffic, and overall market share. These indicators would likely need to turnaround before the company sees any meaningful revenue or EPS gains. The most important factor for this company is the volume of prescriptions being filled in the retail pharmacy business in the US.

Right now, Walgreens Boots Alliance looks significant overvalued using multiple metrics. Citi recently reported that the bank expects a harder landing for the US economy, and comments in February by Goldman Sachs reiterate similar concerns. Citi cited a worsening labor market as signs employers are pulling back. First quarter GDP data was worse than expected as well, and the Fed has also recently committed to keeping rates higher for an extended period of time because of continued concerns of inflation. WBA's debt load has also increased significantly in 2015, and the company also recently cut the dividend to preserve cash, the retailer is likely going to have to allocate more cash to service the debt in the current high rate environment that is likely to remain for some time.

Walgreens Boots Alliance also currently trades 10.47x predicted forward EBITDA estimates and 16.76x forecasted forward EBIT estimates despite management already lowering guidance for this year and growth expectations moving forward being very conservative. Even though the company's five-year average valuation is 11.27x expected forward EBITDA estimates and 14.70x predicted forward EBIT estimates, analysts are projecting that WBA will be able to grow revenues at just 3-5% per year over the next 5 years, and estimates have frequently been too high for the struggling retailer as well. The company's international operations are also just growing at a low single-digit rate despite some strength shown in the Boots franchise in the second quarter as well.

WBA is growing revenues at just a low-single digit rate and the company is operating in a very difficult and increasingly competitive industry. The retailer faces significant competition from far bigger retailers with much better in-store options such as Walmart, Costco, and Target. Amazon is much better positioned than WBA to take advantage of the increasing move to online pharmacies as well, and the online retailer now has their own online clinic as well. The Fed has also signaled rates are likely to remain high, so WBA is likely going to have to preserve cash to service the high debt load the company has as the core business continues to deteriorate, further dividend cuts are likely.

WBA faces cyclical and structural challenges, the company should not be trading at a growth multiple of nearly 17x expected forward EBIT estimates. A company that is only generating modest growth that faces this level of uncertainty should be priced at 7-8x predicted forward EBITDA, or $12-13 a share. Rite went bankrupt just last year, and Walgreens will likely face solvency issues as well if rates remain high and the company is forced to service and try to refinance the retailer's debt load of the core business continues to deteriorate. The company also has $7.53 billion in long-term debt and $1.94 billion in short-term debt, a minor rating downgrade of the company's bonds or continued struggles in the core retail pharmacy would likely put significant pressure on the already weak balance sheet. WBA also has significant lease obligations as well.

WBA is also likely to be limited in the company's ability to return cash to shareholders with the dividend and buybacks moving forward because of the deteriorating core business of the debt load the company faces and the minimal cash flow the retailer is generating.

Walgreens Boots Alliance had been one of the more successful companies in the market for decades, and some investors looking for a reason to invest in the troubled retailer will likely find the management change appealing. Still, the company's core business model has been broken for some time because of specific reasons, and the new leadership team does not have an adequate plan to reverse the multiple secular factors crushing the well-known retailer.

Skeptical12