Multinational retailers have not been faring so well lately; Walmart Stores Inc. (NYSE: WMT) was forced to close 10% of its stores in Brazil while Target’s (NYSE: TGT) foray into Canada was an epic failure. Yet there’s one retailer that has bucked this trend; Walgreen Boots Alliance’s (NASDAQ: WBA) attempt to build a global drugstore empire has paid off handsomely.
Over the past two years Walgreens CEO Stefano Pessina has taken some serious risks. He merged two historic but very different drugstore operators; the American Walgreens and the British Boots, into one company in 2014. Then to top it off Walgreens; America’s largest drugstore chain, is planning to merge with its ailing rival Rite Aid (NYSE: RAD).
One of the World’s Largest Retailers
The resulting company is massive its existing and potential assets include:
8,173 Walgreens and Duane Reade drugstores in the United States.
4,600 Rite Aid drugstores in the United States.
2,510 Boots drugstores in the United Kingdom.
1,028 Benavides drugstores in Mexico.
451 Abumada drugstores in Chile.
261 Boots drugstores in Thailand.
80 Boots drugstores in the Irish Republic.
66 Boots drugstores in the Netherlands.
25 Boots drugstores in Lithuania.
A wholesale network of 301 distribution centers in 12 countries that services around 140,000 pharmacies and medical facilities.
The size of this network is staggering; the current numbers add up to 17,194 drugstores operating under six different brand names in eight countries. These numbers will soon shrink because retail experts think Walgreens will have to close up to 3,000 drugstores in the United States; to control costs and comply with antitrust laws.
That would still make Walgreen Boots Alliance; one of the world’s largest retailers with around 13,355 stores worldwide. It would operate 8,773 stores in the United States alone.
Walgreen Boots Alliance is Vulnerable to Politics
The risks this company is taking extend far beyond normal operating and expansion costs. Walgreen Boots is highly vulnerable to political conditions; because it depends on insurance payments for much of its revenue. Much of Boots’ revenue in the United Kingdom comes from the National Health system, which operates at the mercy of Parliament.
The situation in the United States; where Walgreens has to contend with both private and government health insurance plans, is even more confusing. Many American workers receive private health insurance, which can vary widely in coverage; through their jobs.
Yet 55 million Americans participate in Medicare; the massive federal single-payer health insurance plan for senior citizens. Another 49 million Americans receive Medicaid; a health insurance program designed for the poor. Both Medicare and Medicaid are controlled by Congress, which sets the budget in the United States.
This makes Walgreen Boots Alliance heavily dependent on national-health insurance plans, which are often chronically strapped for cash. The most conservative estimate predicts that Medicare will be facing a 14% budget shortfall by 2030. The Medicaid program in one small US State; New Mexico (population 2.086 million) is facing a $417 million (€362.17 million) shortfall, according to The Albuquerque Journal.
Health insurance in the United States has already gone through radical reforms under the controversial and unpopular Obamacare legislation. Greater changes could be coming because of popular agitation for single-payer health insurance in the country. An initiative that would force the state government to create such a program is on the ballot in Colorado for this fall.
Is the Gamble Paying off?
The risks that Pessina has taken are massive, but so is the potential payoff. The Medicare and Medicaid programs give Walgreens and Rite Aid 104 million potential customers; with government-financed health insurance that covers prescription costs, in the United States alone.
The gamble is paying off for now Walgreen Boots’ revenues increased by $31.95 billion (€27.75 billion) between February 2015 and February 2016, rising from $84.58 billion (€73.46 billion) to $116.53 billion (€101.21 billion).
What is truly interesting is that this figure does not include Rite Aid’s revenues of $30.74 billion (€26.70 billion); because the merger has not been approved by America’s antitrust regulator the Federal Trade Commission. Adding Rite Aid to the mix would give Walgreen Boots $147.27 billion (€127.91 billion) in revenue. Rite Aid’s revenues have also been growing; increasing by $4.21 billion (€3.66 billion) between February 2015 and February 2016.
Although the increased revenue is not paying off yet. Walgreen reported a net income of $3.36 billion €2.92 billion) on February 29, 2016, which $1.112 billion (€970 million) less than the $4.448 billion (€3.86 billion) in November 2015. This drop in income probably resulted from the cost of buying Rite Aid; which cost $9.5 billion (€8.25 billion) in cash and $7.7 billion (€6.69 billion) in debt according to The Street.
Despite that Walgreen managed to generate far more cash. Its cash from operations increased by $1.047 billion (€910 million) between November 2015 and February 2016; rising from $5.365 billion (€4.66 billion) to $6.412 billion (€5.57 billion). The free cash flow grew from $392 million (€340.46 million) in November to $2.036 billion (€1.77 billion) in February. Cash and short-term investments grew from $2.57 billion (€2.23 billion) in November to $3.586 billion (€3.11 billion) in February.
During the same period, Walgreen managed to pay investors a dividend yield of 1.79% and deliver a return on equity of 10.97%. That makes Walgreen Boots, a dividend stock that is capable of significant growth.
The stock is also undervalued; it had a market capitalization of $85.64 billion (€74.38 billion) and an enterprise value of $96.49 billion (€83.80 billion) on April 29, 2016. The $79.29 (€68.86) a share that Walgreen Boots was trading at on April 29, 2016, looks like a bargain.
This makes Walgreen a good buy; because it has the potential for significant revenue and income growth over the next few years. The risks Mr. Pessina has taken could pay off for both him and shareholders. The only potential risk Walgreen faces is significant cuts to government health insurance programs, something that is probably politically impossible.