Shares of pharmacy leader Walgreens Boots Alliance (NASDAQ:WBA) are currently on life support, as nothing seems to be able to stop the never-ending sell-off that has persisted for nearly eight years. In fact, WBA stock has lost more than two-thirds of its value since its 2015 high. This decline has been primarily driven by mounting debt and recent profitability challenges. Thus, while the possibility for a U-turn exists, the stock’s attractive dividend could be at risk. Accordingly, I hold a neutral stance on WBA.
Walgreens’ Massive Debt Load Poses a Great Risk
Walgreens’ massive debt burden threatens the stock’s investment prospects. Notably, total debt stood at $37.4 billion at the end of Q2 of this year. To highlight how massive that is, Walgreens’ total debt is 28.6 times higher than its $1.3 billion in operating cash flows over the past 12 months. Thus, it comes as no surprise that Walgreens has found itself in a precarious position in the face of rising interest rates.
In response to this imperative situation, Walgreens’ board is actively pursuing strategic measures to steer the company toward a more promising trajectory.
Sale of AmerisourceBergen Corporation for $1.85 Billion
Last month, Walgreens announced the sale of shares of AmerisourceBergen Corporation. Walgreens expects to receive proceeds of about $1.6 billion, pursuant to prepaid variable share forward transactions executed through a registered public offering. Depending on the stock price at the time, along with a concurrent share repurchase by AmerisourceBergen, Walgreens expects to record an additional $250 million in proceeds.
These are not huge proceeds, but combined with Walgreens’ routine debt paydown, AmerisourceBergen’s share sale should help in the ongoing deleveraging.
Leadership Transition
Just a few days ago, Walgreens made a significant announcement, revealing that Ms. Brewer would be stepping down from her roles as the company’s Chief Executive Officer and as a Board member, effective August 31, 2023. It is an understatement to say that Ms. Brewer’s performance during her tenure has left much to be desired. Assuming the CEO position in March 2021, Ms. Brewer’s leadership coincided with a substantial decline in the company’s operational performance.
In Fiscal Year 2021, operating profits stood at a robust $5.55 billion. However, in Fiscal 2022, they plummeted to just $3.9 billion. This concerning trend persisted over the past 12 months, with operating cash flows dwindling to a mere $1.3 billion. Hopefully, the Board will be able to find a suitable CEO whose expertise will lead to improving profits. The company won’t see any immediate positive effects from this transition, but Ms. Brewer’s stepping down could prove to be a long-term tailwind to profitability.
Is Walgreens’ Dividend in Danger?
With shares of Walgreens on a downward decline for years, the stock’s yield has been advancing higher by the quarter. This effect has been amplified by the fact that the company has continued to increase the dividend faithfully during this period. On the one hand, Walgreens’ 47-year-long record of successive annual dividend increases is impressive. On the other hand, the company’s declining stock price and ongoing profitability challenges raise questions regarding its sustainability.
For some context here, let’s take a look at the company’s most recent fiscal Q3 results. For the quarter, revenues grew by 8.6% to $35.4 billion compared to last year, or by 8.9% in constant currency. Higher revenues reflected sales growth in the U.S. Retail Pharmacy and International segments and a substantial contribution from the U.S. Healthcare segment.
However, weaker demand for COVID-related services, a more cautious and value-driven consumer, and a recently softer respiratory season created margin pressures in the quarter, according to the company. Accordingly, Walgreens posted an operating loss of $0.5 billion, which even widened from last year’s operating loss of $0.3 billion in the year-ago quarter.
To be fair, this year’s results include a $431 million non-cash impairment of pharmacy license intangible assets in Boots UK. If we exclude these non-cash items, operating income came in at $1.0 billion. Adjusted net income also came in at $860 million, up 3.4% compared to last year.
Still, the dividend is barely covered. Specifically, operating cash flows during the past nine months were $1.22 billion, which couldn’t reach the underlying dividends paid for the period of $1.24 billion. It’s likely that Walgreen’s management is also worried about dividend coverage. This is evident by the fact that the company usually increases its dividend each July. This July, the company skipped such a hike, which signals the lack of affordability in payouts.
Overall, I believe that unless Walgreens takes action to meaningfully deleverage, cut operating expenses, and improve its profitability, its legendary dividend could ultimately be at risk.
Is WBA Stock a Buy, According to Analysts?
Turning to Wall Street, Walgreens maintains a Hold consensus rating based on one Buy, nine Holds, and two Sells assigned in the past three months. At $31.70, the average Walgreens stock price target implies 39.5% upside potential.
Conclusion
In conclusion, Walgreens Boots Alliance finds itself at a critical juncture, with its long-standing dividend facing uncertainty due to lasting profitability challenges. While the sale of AmerisourceBergen shares and leadership transition efforts are steps in the right direction, the company’s massive debt load poses a great risk to the dividend if deleveraging doesn’t take place fast enough.
A turnaround narrative is not out of the question. However, investors should monitor closely how Walgreens navigates these challenges in the coming months.
