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Walgreens: A Dividend Growth Investor's Dream

GuruFocus.com
·10 mins read

- By Nathan Parsh

Dividend growth investing isn't as easy as simply buying stocks trading at a yield that is appealing and then holding forever. Dividend growth investors do seek investments that provide income, but these investors usually have a time horizon that is very long. As these investors plan on living off dividend income in their retirement years, the holding period could easily be several decades.

Company background and historical performance

Walgreens is the largest drug distributor in the world. The company has nearly 14,000 stores around the world, including almost 9,300 stores in the U.S. and its territories. Walgreens added 2,186 Rite Aid stores to its core business in 2017. The company is heavily dependent on its pharmacy business, as nearly three-quarters of last year's revenue came from this segment. General merchandise contributes the remaining quarter. Walgreens has a market capitalization of $31 billion.

Walgreens most recent quarter was challenging. Revenue was essentially flat, but adjusted earnings per share fell 44% and missed Wall Street analysts' projections.

That said, the company's revenue has steadily improved over the last decade.

Walgreens: A Dividend Growth Investor's Dream
Walgreens: A Dividend Growth Investor's Dream

According to Value Line, revenues have doubled over the last decade. Earnings per share has a compound annual growth rate of 10.7% over that same period of time. Share buybacks have contributed a bit to this growth rate, but not very much. Net income has increased with a compound annual growth rate of 10% from 2010 through 2019, meaning that it is been mostly additional profits that have led to earnings per share growth and not share repurchases. I take this to be a very positive sign that the company hasn't overly relied on buybacks to boost earnings results.

Walgreens: A Dividend Growth Investor's Dream
Walgreens: A Dividend Growth Investor's Dream

The GuruFocus system also thinks highly of Walgreens, giving the company an 8 out of 10 rating for profitability. Walgreens does score decently against its peers, but poorly against its own history. Ideally, I would like to see better results compared to the company's previous history. Due to its long-term track record, I feel these rankings will improve over time.

Dividend analysis

Walgreens' most recent dividend increase was announced in early July as the company increased its Sept. 11 payment by 2.1%.

For context, Walgreens' dividend has increased with a compounded annual growth rate of:

  • 5.2% over the past three years.

  • 5.4% over the last five years.

  • 11.7% over the last 10 years.



The most recent raise is below each of the above-listed averages.

Still, Walgreens now has 45 consecutive years of dividend growth. The company is five years away from attaining Dividend King status, a feat accomplished by only another 30 or so other companies.

The company's dividend scores pretty high in most areas according to GuruFocus.

Walgreens: A Dividend Growth Investor's Dream
Walgreens: A Dividend Growth Investor's Dream

Walgreens exceeds its peers in nearly every category. It comes up short against its own history in terms of payout ratio and dividend growth, but you will see in a minute why I am not as concerned about that.

The stock offers a forward dividend yield of 5.1% as of Monday's close. This is higher than more than 90% of companies in the health care providers and services industry. This is also close to Walgreens' highest yield in a decade.

Walgreens: A Dividend Growth Investor's Dream
Walgreens: A Dividend Growth Investor's Dream

For context, Walgreens hasn't averaged a yield above 2.8% for an entire year since at least 2004. The average yield over the last decade is 2.2%. The stock's current yield truly is in unchartered territory.

That may worry some that the dividend could be at risk of being cut, but the payout ratios should put investors at ease.

Walgreens: A Dividend Growth Investor's Dream
Walgreens: A Dividend Growth Investor's Dream

As you can see, the dividend sits comfortably below both the company's earnings per share and free cash flow per share values.

Let's dig deeper into those numbers.

Walgreens has distributed $1.84 of dividends per share over the last four quarters while producing earnings of $5.15 per share for a payout ratio of 36%. This is in line with the 10-year average payout ratio of 34%.

The company has paid out $1.7 billion in dividends over the last year while generating free cash flow of $4.4 billion, resulting in a free cash flow payout ratio of 39%. The average free cash flow payout ratio since 2017 is 31%. The recent payout ratio is elevated compared to the historical average, but remains in a very safe range.

Walgreens' dividend should be very attractive to investors looking for income. The yield is almost 2.5 times that of its 10-year average yield. High yields can be a warning sign, but both the earnings per share and free cash flow payout ratios are very reasonable. Walgreens has also raised its dividend for almost five decades now, a feat only made possible by the company's ability to thrive even in a recession.

Recession performance

For companies with long track records of dividend growth, the underlying businesses need to remain stable during harsh economic periods. Companies that have difficulty staying profitable often have to cut dividends.

Listed below are the EPS results for Walgreens before, during and after the last recession:

  • 2006 earnings per share: $1.72

  • 2007 earnings per share: $2.03 (18% increase)

  • 2008 earnings per share: $2.17 (7% increase)

  • 2009 earnings per share: $2.02 (7% decrease)

  • 2010 earnings per share: $2.16 (7% increase)

  • 2011 earnings per share: $2.64 (22% increase)



Walgreens' earnings per share did decline in 2008, but only at a single-digit pace. Earnings were essentially flat from 2007 to 2009, an impressive showing given the economic environment at the time. Even better, the share count remained nearly the same, showing that the business itself was responsible for the earnings performance, not financial engineering. It did take the company until 2011 to make a new high for earnings per share, but Walgreens barely skipped a beat during the last recession. Since then, the company has failed to improve earnings per share only twice (2012 and 2019) and then the declines were small and brief.

Managing to maintain its profitability during the last recession also allowed the company to continue to grow its dividend. Listed below are the dividends paid out each year before, during and after the last recession:

  • 2006 dividends: 27 cents

  • 2007 dividends: 33 cents (22% increase)

  • 2008 dividends: 40 cents (21% increase)

  • 2009 dividends: 48 cents (20% increase)

  • 2010 dividends: 59 cents (23% increase)

  • 2011 dividends: 80 cents (36% increase)



Looking at the dividend increase from 2007 through 2009, you wouldn't have known there was a recession even occurring or impacting Walgreens all that much. The company increased its dividend at better than a 20% clip for multiple years during and after the worst part of the recession.

Given its past performance, it is highly likely that Walgreens would continue to raise its dividend during the next recession, albeit likely at a lower rate given recent increases. In total, the company has managed to deliver dividend growth through the past four recessions. Past performance is no guarantee of future success, but Walgreens' showing during the last recession should give investors confidence that it would likely be able to continue growing its dividend in the next crisis.

Debt

If there is an area of concern with Walgreens, it is the company's financial strength.

Walgreens: A Dividend Growth Investor's Dream
Walgreens: A Dividend Growth Investor's Dream

The company receives a mediocre score of 4 out of 10 according to GuruFocus. The major issue is that the company's rankings compared to its own history are rather poor. For example, cash-to-debt, debt-to-equity and interest coverage are all at or near the lowest ratings in the company's history.

They also don't measure up to well against the rest of Walgreens' peers either.

The primary contributing factor to these ratings is the amount of debt Walgreens has taken on in recent years. Total debt has ballooned over the past few years due to acquisitions. Future results should benefit from the additions to the business, but the company had to take on debt to complete them.

On the plus side, financing the company's debt shouldn't be an issue. Walgreens' total debt stood at $12.1 billion as of the most recent quarter. The company's interest expense over the last four quarters was $657, which results in a weighted average interest rate of 5.4%.

After subtracting dividends from free cash flow over the last year, Walgreens still had $2.7 billion to use toward paying its interest expense and debt obligations.

The current interest coverage ratio is lower than usual for the company, but I am confident that Walgreens has enough excess free cash flow to meet its obligations. This means that the dividend likely isn't at risk due to the company's debt.

Valuation

Shares of Walgreens closed the most recent trading session at $36.62. According to Yahoo Finance, consensus estimates call for earnings of $4.69 per share for the year, giving shares a forward price-earnings ratio of 7.8. The five and 10-year average price-earnings ratios are 15.3 and 15.9, respectively. The current valuation is approximately half of its historical average.

I've stated on several occasions that I find Walgreens to be an extremely undervalued stock.

And the GF Value Line is in agreement.

Walgreens: A Dividend Growth Investor's Dream
Walgreens: A Dividend Growth Investor's Dream

For those not familiar with the GF Value Line, it represents the current intrinsic value of a stock based on a variety of factors, including price-earnings ratio, price-to-free cash flow, the company's past returns and future estimates of business performance.

Based on these factors, GuruFocus believes that Walgreens' GF Value is 81.04. This equates to a price-to-GF-Value of 0.45, easily placing Walgreens in significantly undervalued territory.

Sometimes companies look extremely undervalued, but are actually in a long-term decline. This doesn't appear to be the case for Walgreens when you consider the revenue or EPS growth rates referenced earlier. Walgreens is not exhibiting any indications that its business is in a severe, downward decline.

Shares don't even have to return to the 10-year average valuation to result in significant gains. Trading at 10 to 12 times earnings would result in the stock being worth $47 to $56, which would be an increase of 28% to 53% from the current price. And that is before the dividend yield is factored in.

Final thoughts

Walgreens looks to be everything a dividend growth investor could want in a stock. The company's revenue has grown steadily higher over the years. Earnings have compounded at a double-digit clip and without the need for share repurchases to artificially prop up earnings per share results.

Walgreens is approaching almost five decades of dividend growth, an accomplishment that should be valued by dividend growth investors.

In addition to offering a very high yield, Walgreens trades at an extremely low forward price-earnings ratio. A slight reversion toward its average valuation would result in tremendous gains.

Because of the possible returns and dividend track record, I continue to find Walgreens a very attractive stock.

Disclosure: The author has no position in any stocks mentioned in this article.

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This article first appeared on GuruFocus.