The fact that it isn’t actually trading at a bargain is the least important factor.
If you’re thinking about buying shares of Walgreens Boots Alliance (WBA 0.61%) anytime soon, you’ll need to appreciate the position that the well-known pharmacy and retailer is currently in. Amidst an attempt to integrate into healthcare markets outside of its traditional wheelhouse, the company’s financial position has deteriorated, and it’s on the road to becoming downright precarious.
But some investors may see the potential for things to improve where others might only appreciate risks. So let’s investigate three items you need to understand before buying this stock.
1. It’s facing stiff competition in its only real growth segment
Over the last few years, Walgreens has tried to enter the primary-care market by providing some basic services through its VillageMD subsidiary. The move was a bid to enter into a quickly growing market so Walgreens could get exposure to a tailwind for its growth. There is some evidence that the plan is working.
Sales in its healthcare segment rose by 8% year over year in its third fiscal quarter, reaching $2.1 billion. That’s a significantly larger amount of growth than in the core retail pharmacy business, which grew revenue by 2.3% to arrive at $28.5 billion, while adjusted gross profit fell by 6.7%.
So even if the healthcare segment isn’t very large in comparison to the others, it’s the fastest-growing. And it’s on track to yield operating profits, as its adjusted operating losses were just $22 million, an improvement of $150 million from a year prior. But if CVS Health has anything to say about it, Walgreens will face a stiff headwind to its growth segment.
At the moment, CVS generates far more free cash flow (FCF) each quarter than Walgreens does. It’s also more profitable, and a larger business. And it’s making the same diversification attempt into primary care, right when Walgreens is.
Put differently, with Walgreens in retreat and CVS on the advance, the gap between the two in the primary-care segment will only grow from here. That’s something you need to know if you’re thinking of buying either stock.
2. It doesn’t have a great track record for investing its capital efficiently
As an investor, it’s important to know whether a business is going to make good use of the capital it has on hand, as well as the capital it can draw on in the form of debt and shareholders’ equity. On that basis, Walgreens leaves a lot to be desired, and it has for a long time. Take a look at this chart:
WBA Operating Margin (Quarterly) data by YCharts.
As you can see, over the last 10 years its three-year median return on invested capital (ROIC) and its return on assets (ROA) have decreased and are negative. Effectively that means its capital investments over the last three years have largely been value-destroying rather than value-generating, and that its existing assets are not being operated in a way that creates a positive return.
For a retail footprint-intensive company like Walgreens, another takeaway from these figures is that its retail locations are, on average, no longer the good investments that they may have been in the past. This is substantiated by its plans to shutter many of its stores over the coming years. An additional risk is that as those stores are closed and the real estate is sold off, the company won’t be able to recoup the cost of buying the land in the first place.
3. It’s unclear how management is planning to turn things around
In its third-quarter earnings announcement, when Walgreens announced a significant reduction in its number of locations, management signaled that a general transformation of the business was ahead. But there were few specifics about what the result would be after the transformation was complete — an ambiguity that any potential investors need to understand in full.
For instance, it’s clear that the pharmacy segment will continue on. Beyond that, it’s hard to see how management is going to rekindle growth, or at least to stem the substantial and growing losses from operations.
The diversification play into providing primary care via the VillageMD subsidiary is now at risk, with management mentioning that it may be necessary to “unlock liquidity.” That could mean anything from backing out of advance purchasing deals to recoup cash, to selling off assets that might currently be productive.
A temporary retreat from the far reaches of its primary-care ambitions would imply the opportunity to return later, when financial conditions improve. But a fire sale would likely slam that door shut. Management simply isn’t sharing enough information for investors to know which route is favored, and it’s key for anyone considering an investment to appreciate that.