Walgreens (WAG) Dividend Stock Analysis

Walgreens is one of the largest chain drugstores in the US, with around 8,400 locations in all 50 States.  In 2012, Walgreens controlled about 19% of the US prescription drug market.  In 2012, WAG acquired a 45% interest in Alliance Boots, an international pharmacy store (over 3,000 pharmacies worldwide) and wholesale drug distributor.  Walgreens also has the option to acquire the remaining 55% interest in 2015.

In terms of sales, approximately 65% of sales arise from prescription drugs, 10% from non-prescription (over the counter) drugs, and 25% from general merchandise.

In 2012, the contract between Express Scripts and Walgreens expired.  Express Scripts is a major pharmacy benefits manager (PBM).  PBMs are third party administrators of prescription drug programs responsible for processing and paying prescription drug claims.  The contract dispute centered around Walgreens wanting more money per prescription than Express Scripts was willing to pay.  During the time of the dispute, approximately 88 million prescriptions were affected, meaning that they could not be filled at Walgreens during the period of the dispute.  Eventually the contract dispute was resolved and in September of 2012, Walgreens was once again admitted to the Express Scripts network.  Unfortunately, the damage from this dispute still lingers on.

WAG Basic Company Stats

• Ticker Symbol: WAG
• PE Ratio: 18.57
• Yield: 2.66%
• % above 52 week low: 98.4%
• Beta: 1.22
• Market cap: $37.49 B
• Website: www.walgreens.com

WAG vs the S&P500 over 10 years

WAG generally seems to be tracking the S&P500 index over the last 10 years and is currently under performing it.  After 10 years WAG is up about 30% compared to the S&P500 being up about 70%.

WAG Earnings Per Share (EPS) & Dividend Growth

• 5 year EPS growth: 2.8%
• 10 year EPS growth: 8.7%
• 5 year dividend growth: 24.1%
• 10 year dividend growth: 9.2%

EPS for Walgreens have been growing rather nicely over the last 10 years.  Walgreens didn’t seem too badly affected by the Great Recession, but 2012 has seen a big dip in WAG’s EPS due to the conflict with Express Scripts.  The 10 year dividend growth rate was 9.2%, the five year growth rate was 24.1%, and the one year growth rate was 26.7%.  It looks like WAG is entering a period of accelerating dividend growth.  This is a good thing.

With a starting yield of 2.8% and a growth rate of over 20%, WAG will hit hit over 15% yield on cost (YOC) in 10 years.  It’s unlikely that this growth rate will be sustained over the next 10 years, so if use a more conservative 10% growth rate, the 10 year YOC will be 7.8%, or a less conservative 13% growth rate, the 10 year YOC will be around 10%.

Using the rule of 72, it will take approximately 7 years for the  yield to double assuming a conservative 10% growth rate.

WAG Payout Ratio

WAG’s payout ratio has remained below 30% for 9 out of 10 of the last years.  In 2012, the payout ratio was 39%, due to the dip in EPS.  The average payout ratio over the last 10 years is 21%.  This is great.  This low payout ratio leaves lots of room for dividend growth as well as capital improvements in the company.

WAG Cash Flow and Revenue

• 10 year revenue growth (2003-2012): 9.2%
• 5 year revenue growth (2008-2012): 5.0%
• 3 year revenue growth (2010-2012): 3.0%

WAG’s revenue and cash flow have been consistently increasing over the last 10 years.  2012 was a bit rough on WAG thanks to it’s largely ridiculous conflict with Express Scripts.

It is likely that as the economy improves and time heals the wounds left by the Express Scripts dispute that WAG’s revenue and cash flow will continue to increase.

WAG Balance Sheet

The current debt to equity ratio is 34.74%.  Over the last 10 years, the debt to equity ratio has hovered in the 40% to 60% range.  It would be nice if this was lower, but the fact that it is stable is reassuring.

WAG Risks

The main risk to Walgreens, namely the contract dispute with Express Scripts, has passed.  Now it’s up to Walgreens to aggressively work to mitigate the damage and  bring back those customers that it lost.  If Walgreens cannot easily regain those customers it’s future growth may be slowed.  The other major risk to WAG comes from the slow economic recovery.  General merchandise, which is sensitive to consumer spending patterns, accounts for about 25% of WAG’s sales.

WAG Graham Number Valuation

The Graham number represents one very simple way to value a stock.  The Graham number for WAG is $31.10, which suggests that WAG may be overvalued.

WAG Cash Secured Puts

At this point, I wouldn’t sell long term cash secured puts against WAG.  The stock seems a touch overvalued and I suspect that assignment may be likely.  However, if the economy continues to substantially improve this year, long term puts may be a good option.

I would also consider selling short term puts, a bit above the strike price, with the intent of being assigned the stock.

Conclusions

With the express scripts conflict behind them and the ongoing acquisition of Alliance Boots, Walgreens is in a great position to expand.  The dividend payout ratio is low and WAG appears to currently be in a phase of rapid dividend growth.  I do feel that WAG is slightly overvalued and I wish the yield was a bit closer to 3%, but I feel that WAG is worth purchasing due to the incredible dividend growth prospects.

Disclosure: None.

Readers:  What are your opinions about Walgreens?