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Plain Dividend Yield’s For Chumps: But Rising Payout at Walgreen Comes With Risk

Carla Fried

Over the past five years, drug-store chain Walgreen (WAG) has increased its dividend at a 23.7% pace. That ranks as the second highest dividend boost among the S&P 500 Dividend Aristocrats -- companies that have delivered annual dividend increases for at least 25 consecutive years.

This article is one of a series on dividend growth.

Walgreen management has made dividend payouts and share repurchases a focal point of its Plan to Win strategy that was rolled out in early 2009. Walgreen’s says the $7 billion it returned to shareholders over the past four years in dividends and share repurchases is about what it paid out from 1934-2008.

The aggressive dividend growth strategy bears watching. As the chart below shows, the core payout ratio has doubled since 2009. If that trend continues it reasons that the pace of dividend growth would need to slow.

WAG Cash Div. Payout Ratio TTM Chart

The big 2012 spike in the payout ratio is in large part a function of a self-inflicted business wound. Walgreens picked a fight with pharmacy benefits manager Express-Scripts (ESRX) that ended with Walgreens getting kicked off of Express-Scripts’ list of in-network pharmacies for group health plans. For the first nine and a half months of 2012 consumers had to switch to another in-network pharmacy or pay more to keep filling their prescriptions at Walgreen. Walgreen says most customers left. For Walgreen’s fiscal 2012 year, ending August 30th, revenue ticked down nearly 1% and earnings per share cratered 17.7%.

Walgreen’s boneheaded misstep was cheered by CVS Caremark (CVS), which was happy to pick up Walgreen’s Express-Scripts customers. This stock chart shows the stretch from when Walgreen started arguing with Express-Scripts, to the mid-July 2012 announcement that the argument was over and Walgreen was back in the back in the Express-Scripts fold.

WAG Chart

Walgreen isn’t expected to win back all the customers who left in 2012, but Wall Street clearly feels the proverbial corner has been turned. Following Walgreen’s late-December release of its first quarter results for FY 2013, its stock is up 7.5% compared to a 5.4% gain for CVS Caremark and a 3% gain for the S&P 500 stock index.

Walgreen’s current PE ratio is above the market average of 14.4 but it is actually right around the stock’s low for the past 10 years. With a 2.7% current dividend yield and management’s commitment to growing the dividend, that might set some value antennae abuzz. One factor to watch going forward is its debt load. This past summer Walgreen floated $4 billion in new debt, in part to finance the $6.7 billion cost of buying a 45% stake in Alliance Boots, a Euro-centric drugstore chain that gives Walgreen’s more exposure to international markets.

WAG Debt to Equity Ratio Chart

And there’s plans for more debt (Walgreen has an option through 2015 to buy the other 55% of Alliance Boots). The company says it expects its net debt to rise to $11 billion in FY 2016, more than double the current level. That said, this is a very healthy company, despite its recent woes. Walgreen’s posted impressive free-cash flow growth of 44% for the trailing 12 months. Over the past five years, free cash flow has grown more than 5-fold to more than $2.7 billion.

Carla Fried, a senior contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine. She can be reached at editor@ycharts.com.

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