Walgreens: Profits In Free-Fall, No Cure In Sight

seekingalpha11-19

Walgreens Boots Alliance faces significant profitability challenges, including an $8.6 billion net loss in FY24, with plans to close 1,200 stores by 2027.The investments in VillageMD aren't paying off...

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I’m sticking with a strong sell rating.Eric Broder Van Dyke/iStock Editorial via Getty Images  Walgreens Boots Alliance, Inc. (NASDAQ:WBA) has seen its profitability decline significantly in the past year, with a reported net loss of $8.6 billion. This doesn't seem to be a one-off issue. Both profits and the share price have been steadily declining over the last five years. Seeking Alpha In this article, I will break down some of the main challenges that Walgreens is currently facing and provide my rationale for why I believe there are no clear signs of a turnaround in the midterm. However, I will advance in this introduction that the decline in profitability, coupled with management's plans to close 1,200 stores by 2027, with 500 of those shutting down in FY 2025, plays a fundamental role in my bear thesis. As always, I will cover some of the risks to my thesis, including the company's attractive valuation ratios, which, I believe, could appeal to speculative value investors. For now, I will begin my thesis with what, I believe, is one of the most significant challenges the company is currently facing. A Big Decline In Profitability In FY 2024, Walgreens experienced a net loss of $8.6 billion. On top of that, the company plans to close 1,200 stores in the next three years, with roughly 500 of the closures slated for fiscal 2025. Over the past five years, both net income and the share price have shown a clear downward trend. Seeking Alpha The loss per share for FY 2024 rose to $10.01, a 180.4% increase compared to the prior year. Even adjusted EPS fell by 27.9% YoY. One of the factors was a goodwill impairment charge of $12.4 billion related to one of its subsidiaries, VillageMD. Walgreens initially invested $1 billion in VillageMD in 2020, with another $5.2 billion investment a year later. They later used M&As to increase Village MD's network of physician offices. The long-term financial expectations for this subsidiary were adjusted downward due to slower than anticipated patient panel growth. During the Q2 FY24 earnings call, the CFO, Manmohan Mahajan, mentioned that recent modifications in Medicare reimbursement models adversely affected VillageMD's revenue streams. Including the impact of closing approximately 160 clinics, inclusive of the 60 previously communicated, slower than expected trends in patient panel growth and multi-specialty productivity and recent changes in Medicare reimbursement models. Will Management Divest VillageMD? Well, it seems that the company is exploring several options regarding its investment in VillageMD, including selling all or part of its stake. At the moment, no official decision has been made, however, the CEO, Tim Wentworth, announced plans to decrease WBA's stake in this subsidiary. In my view, if an asset is not making money (from a profitability perspective), and if there are no clear indications that it will be in the mid to long term, the best decision is to get rid of it as soon as possible. Some investors might use the argument that VillageMD's revenue grew by 7.2% YoY in the most recent fiscal quarter. However, when excluding the effects of the goodwill impairment (i.e. the $12.4 billion non-cash expense), the US Healthcare segment reported an operating loss of $134 million in FY24. Lastly, I considered adding a detailed table that includes most of the profitability metrics I usually evaluate in a company. Stock Rover From the table above, I find concerning the decline in gross margin, the negative operating, EBITDA, and net margins in the last two fiscal years. Finally, the negative 83% ROE doesn't look particularly attractive. For a highly established company like Walgreens, these metrics play a significant role in my investment style. Therefore, I am not encouraged to see this decline in profitability. Insider/Activist/Institutional Activity A closer look at the latest insider transactions shows a lack of activity since April this year. Back then, the CFO and one of the directors purchased shares in the company, however, it wasn't a significant amount. OpenInsider On a side note, I prefer to see insider purchases exceeding $200k per individual, with at least three executives buying within a short timeframe. If I notice this kind of contrarian investment activity, I try to identify the growth driver that encouraged these insiders to buy. However, with only three small transactions this year, there's not enough buying activity to draw any conclusions. On the positive side, there has been no insider selling activity this year. A closer look at the last 13D/Gs shows a 20% reduction in ownership from State Street Corp in mid-October. Earlier this year, in January, they reduced their ownership by 6%. Additionally, the number of shares owned by institutional investors decreased by 2% in the last quarter. The number of increased positions declined by 18%, and the number of funds holding positions in Walgreens decreased by 8% in Q3. Overall, I see insiders and investment funds maintaining a cautious approach. I recommend keeping a closer eye on these transactions. If I notice a cluster of insider buying or a new activist fund taking a significant position in the company, I might reconsider my strong sell rating. Valuation Considering the 80% decline in the share price over the last 2 years, I am not surprised to see most valuation ratios trading close to their minimum historical range. Stock Rover Let's have a closer look now to see how these ratios compare to the median of the consumer staples sector. I am using Seeking Alpha's valuation page for this comparison analysis. A quick look at the valuation table shows P/S trading 95% below the sector median. If we look at P/B or P/CF, we will arrive at the same conclusion: the company seems to be undervalued when compared to its sector. However, in my view, this stock could be a value trap. Why? Well, let's have a closer look at the guidance management provided for the next fiscal year. Walgreens Boots Alliance PR Let's assume they achieve the mid-point sales guidance by the end of FY25. This would represent a 0.9% increase YoY in sales. In my view, this figure will not be enough to spark interest in institutional investors (let alone retail investors). Additionally, as I already mentioned before, the company is expecting to close 1,200 stores over the next 3 years, with 500 in FY25 alone. How I Can Be Wrong As mentioned earlier, the company's valuation ratios appear quite appealing to value investors. It's possible that speculative investment firms might step in, attracted solely by these low valuation ratios. If this happens, it could help stabilize the share price and put a stop to the steep decline it has experienced over the past 9 years, when the share price was trading close to $100. Another factor that could break my bear thesis is the success of UK's Boots.com, which recorded a 19% increase in sales YoY. Also in Europe, sales in Germany grew by 8.2%, driven by strong performance in the wholesale business. Finally, the company achieved in FY24 over $1 billion in cost savings, reducing capital expenditures by $736 million. This gives them some oxygen to reinvest in growth initiatives. One potential move could be the divestiture of VillageMD. Currently, there's no clear decision regarding the future of this subsidiary. However, as I mentioned earlier, selling it could be a positive step from a profitability point of view. Conclusion To wrap up, I maintain a strong sell rating on Walgreens, mainly due to its ongoing deterioration in profitability and operational challenges. I remain concerned with the financial downturn of the company, including a net loss of $8.6 billion in FY24, coupled with a 180.4% increase in loss per share. Even adjusted EPS declined by 28% YoY. Other concerns include the unfavorable performance of VillageMD. Despite revenue growth, the US Healthcare segment reported an operating loss of $134 million in FY24 (excluding significant non-cash items). Additionally, I believe that the muted sales growth forecast of 0.9% YoY for FY25 is unlikely to reignite investor confidence, especially when considering that the company plans to close 1,200 stores over the next three years, including 500 in FY25. There are some risks to consider, including attractive valuation ratios, which could attract (speculative) value investors. Growth in European markets, especially through Boots.com and the German wholesale business, could also help to drive some growth in FY25. Finally, the company saved over $1 billion in FY24, which could be used to fund new initiatives.  At the moment, without any clear signs of a real turnaround, I expect the headwinds to continue.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"-2","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":1,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.2","shortVersion":"4.29.2","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2484142968"}