Worst of Self-Inflicted Mess at Walgreens Appears Over: a Bargain Into 2013?
To many on Wall Street, Walgreens (WAG) remains foremost a self-emaciated company, the victim of a colossal strategic error that gave competitor CVS Caremark (CVS) an enormous boost. But with the worst of those consequences behind it, some investors see in Walgreens the makings of a decent value play. Its share price, which typically played underdog to CVS since the grand mistake, is up some 24% in the past six months to CVS’s 5% gain, as seen in a stock chart.
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To be sure, pursuing Walgreens now would constitute boldness while others still fear. CVS remains the darling of the sector, having made away with oodles of Walgreens’ customers and investors in the past 18 months. More than 20 analysts recommend buying CVS shares now, which is almost everyone that follows it. Walgreens gets a much more mixed reaction from that community.
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But 2012 will close out many of the problems that led to Walgreens’ disgrace, leaving intact one of the most popular drug store chains in the nation. With the summer’s purchase of a 45% stake in Britain’s Alliance Boots, it also becomes one of the biggest prescription drug buyers in the world and gains bargaining power with the status. And with a 3% dividend yield and more than a decade of steady dividend gains, it remains an income play worth investigating.
Walgreens’ issues started with a tiff with Express Scripts Inc. (ESRX) in the summer of 2011. As the country’s second largest pharmacy benefits manager, Express Scripts sets the “approved provider” lists for tens of thousands of patients, essentially determining whether they will fill their prescriptions at Walgreens or not. Walgreens’ haggling led Express Scripts to send its customers – and their shampoo, toothpaste and high-margin snack purchases too – to CVS and other competitors for most of a year. Walgreens and Express Scripts made nice in September, which gives Walgreens at least a fighting chance of winning them back.
Walgreens optimists believe both pharmacy and store profits will rise as it wins back Express customers, even if it can only recoup half or so as many as it lost. Widening profit margins suggests it didn’t cut a desperation deal to settle things.
Many investors consider Walgreens shares now to be cheaper than they’ve been in a decade. It’s a bargain that’s a little hard to see in recent earnings reports, however, which have been chock full of particularly vexing unusual situations. (Including an unexpected one-quarter reporting lag on earnings connected to the Alliance Boots acquisition.) The PE ratio chart below shows low points based on earnings earlier this year. The share price now is about 11 times estimates for 2013 earnings.
It’s a nice case for Walgreens as an obscured bargain; the kind of underappreciated share that makes value investing profitable. Just don’t expect CVS to go along with the plan.
Dee Gill, a senior contributing editor at YCharts, is a former foreign correspondent for AP-Dow Jones News in London, where she covered the U.K. equities market and economic indicators. She has written for The New York Times, The Wall Street Journal, The Economist and Time magazine. She can be reached at editor@ycharts.com.
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