Jan 19, 2016
Walgreens Boots Alliance,
Inc.
(WBA-NASDAQ)
$79.93*
Note: This report contains substantially new information. Subsequent reports will have changes highlighted.
Reason for Report: 1Q16 Earnings
Previous Ed.: Nov 12, 2015; 4Q15 and FY15 Earnings (broker material considered till Nov 5, 2015)
Brokers’ Recommendations: Positive: 56.3% (9 firms); Neutral: 43.7% (7); Negative: 0.00% (0)
Brokers’ Target Price: $94.31 (↓$2.24 from the last edition; 16 firms)
Prev. Ed.: 8; 10; 0
Brokers’ Avg. Expected Return: 18%
*Note: Though dated Jan 19, 2016, share price and brokers’ material as of Jan 15, 2016.
Note: A Flash update on ‘1Q16 Earnings’ was done on Jan 8, 2016.
Note: The tables below for Revenue, Margins, and Earnings per Share contain fewer brokers’ material than the brokers’
material used in the Valuation table. The extra figures in the Valuation table come from reports that did not have
accompanying spreadsheet models.
Portfolio Manager Executive Summary
Walgreens Boots Alliance (WBA) operates as a leading retail pharmacy chain in the U.S and Europe. Its
portfolio of retail and business brands includes Walgreens, Duane Reade, Boots and Alliance Healthcare,
and global health and beauty product brands, such as No7 and Botanics. The company was formed
through the combination of U.S.-based pharmacy giant Walgreen Co. and its European counterpart
Alliance Boots GmbH on Dec 31, 2014.
Of the 16 firms covering Walgreens, 9 (56.3%) assigned positive ratings while 7 (43.7%) provided
positive ratings. None of the firms provided a negative rating on the stock.
Neutral or equivalent outlook (10/18 firms): For majority of the neutral firms, Walgreens Boots’ 1Q16
EPS exceeded both their estimated figures as well as the market expectation. According to one firm, this
EPS beat was primarily driven by strong retail comparable sales and a healthy performance at the
international segment. Another firm attributed Walgreens Boots’ better-than-expected same store sales
and gross margin for the EPS beat. However, according to one firm, the company’s revenue figure
missed its estimate as well as the market expectation. The firm considers a weaker-than-normal start to
the flu season responsible for this sales miss. However, the firm is impressed with the better-thananticipated cost cutting initiative of Walgreens Boots and believes that the company is on track to reach
its desired profitability target for FY16.
As far as the Rite Aid acquisition is concerned, a few neutral firms expect limited financial impact on
Walgreens Boots in the near term, along with a lengthy regulatory review process. They believe that
strategically, the Rite Aid deal will significantly benefit Walgreens Boots’ U.S. retail pharmacy segment.
On the flip side, they continue to foresee tough challenges with respect to pharmacy margins on account
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of a less favorable generic launch pipeline as well as reimbursement pressure. Higher generic drug
costs also added to the woes in the reported quarter and are expected to continue in the near term as
well.
Positive or equivalent outlook (8/18 firms): For the majority of the bullish firms, Walgreens Boots’
1Q16 EPS figure exceeded their estimates as well as the market expectation. According to one firm,
Walgreens Boots’ cost transformation and Boots synergy initiatives outweighed gross margin pressure
on the company’s overall business, driven by specialty mix and growth in Medicare Part D exposure.
This in turn drove the EPS beat. The firm was also impressed with the company raising the lower end of
its EPS guidance range for FY16, despite anticipating a significant foreign exchange headwind.
According to another firm, in addition to the positive impact from the Alliance Boots merger, a strong
growth in retail comparable stores drove solid year-over-year growth in the retail pharmacy USA
division. The firm was also upbeat about the company’s front-end operations in 1Q16, which according
to it benefited from a deliberate strategy to move mix to core focus Health & Beauty categories.
While discussing the retail pharmacy international division, one of the firms was upbeat on Walgreens
Boots’ focus on selling lower volumes of higher margin products, which according to it contributed to the
strength of this division. The firms also speak highly about the company’s continued progress on its
previously stated goal of $1 billion in combined net synergies in FY16, in addition to other cost
management efforts, like the AmerisourceBergen generic sourcing initiative and lower SG&A expenses.
Jan 19, 2016
Overview
Headquartered in Deerfield, IL, Walgreens Boots Alliance is the first global pharmacy-led, health and
wellbeing enterprise in the world, with over 13,100 stores in 11 countries. Walgreens Boots was formed
through the combination of U.S.-based pharmacy giant Walgreen Co. and its European counterpart
Alliance Boots GmbH on Dec 31, 2014. In Jun 2012, Walgreens had entered into a long-term partnership
with Alliance Boots under which the former acquired 45% equity ownership of the latter. On Dec 31, the
remaining acquisition of Alliance Boots was completed and the new company, Walgreens Boots Alliance,
Inc. was formed, of which legacy Walgreens is now a wholly-owned subsidiary. The company’s website is
www.walgreensbootsalliance.com.
Currently, Walgreens Boots has a presence in over 25 countries, with an employee structure of more
than 370,000 people and is the largest retail pharmacy, health and daily living destination in the U.S. and
Europe. It is the largest global pharmaceutical wholesale and distribution network with over 350
distribution centers delivering to more than 200,000 pharmacies, doctors, health centers and hospitals
each year in 19 countries.
Post completion of the merger on Dec 31, 2014, Walgreens Boots realigned its operations into three
reportable segments: Retail Pharmacy USA, Retail Pharmacy International, and Pharmaceutical
Wholesale. Segmental reporting includes the allocation of synergy benefits, including WBAD results, and
the combined corporate costs for periods subsequent to Dec 31, 2014.
Walgreens Boots began recording revenue and expense transactions for the new segments effective Jan
1, 2015. Beginning Jan 1, synergy benefits including Walgreens Boots’ operations have been allocated to
the Retail Pharmacy USA, Retail Pharmacy International and Pharmaceutical Wholesale segments on a
"source of procurement benefit" basis. Under this method, the synergy benefits are allocated to the
segment whose purchase gave rise to the benefit.
The company’s fiscal year ends on Aug 31; all calendar references differ from the fiscal year.
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The firms identified the following factors for evaluating the investment merits of WBA:
Key Positive Arguments
Health & Wellness Division: Walgreens is
strengthening its health and wellness division
with acquisitions and is growing its presence in
specialty pharmacy, which has substantial growth
potential.
Key Negative Arguments
Declining Margins: Over the past few years, increased
reimbursement pressure and generic drug cost inflation
has been hampering legacy Walgreens’ margin, on a
significant level. The management does not expect this
situation to improve in the near term.
Initiatives:
The
company is
constantly
introducing strategic initiatives to boost long-term
growth. Many firms believe that Walgreens’
recent partnership with WebMed will elevate its
position in the digital market. Besides, it also has
the potential to drive foot traffic at its stores.
Regulations: The continued efforts of health maintenance
organizations (HMOs), managed care organizations,
PBMs, and other third party payors, including government
agencies such as Medicaid, to cut costs by reducing
prescription drug costs and reimbursement rates could
pose a threat to Walgreens’ future operating performance.
Strong Balance Sheet: Buoyed by a strong
balance sheet, the company regularly returns
value to shareholders through dividends and
share repurchases. Moreover, a strong cash
balance augurs well for acquisitions.
Low Generic Drugs Introduction Rate: Walgreens Boots
expects the trend of low introduction rate of new generic
drugs to continue in FY16.
Improved Supply Chain: The long-term deal
with AmerisourceBergen is another upside. The
firms are sanguine about improved supply chain
performance in the next fiscal. Moreover, they
are encouraged by the expected accretion from
this deal.
Jan 19, 2016
Long-Term Growth
For the long term, Walgreens Boots has structured its growth and expansion plan on three strategic
pillars. First, Walgreens Boots will seek and seize further synergy opportunities, while continuing to
optimize its cost base across the enterprise. Second, management seeks to drive the company’s organic
growth by making the most of a well integrated wholesale-retail model and its brands. Last, Walgreens
Boots will pursue to generate and seize relevant merger and acquisitions and strategic investment
opportunities in mature and emerging markets.
Notably, emerging markets represent another longer-term strategic opportunity that the company plans to
capitalize on in pursuance of Walgreens Boots’ future growth. Management believes the company is well
placed to serve as a catalyst of change in the substantial Chinese market. Moreover, its recent
acquisitions in Mexico and Chile position it well to eventually become an influential player in the Latin
American market. These markets should create further opportunities for Walgreens Boots to advance the
health and wellbeing of communities around the globe.
Post-merger, Walgreens Boots’ first priority as a combined entity is to understand the business fully,
along with its interdependency and its differentiation. Currently, management focuses on delivering as
per the needs of Walgreens Boots’ customers in a dependable yet innovative manner that will provide the
company with sustainable and growing income across all parts of its business.
Management aims to achieve this through a combination of efficient practice, research, and insight,
investment in Walgreens Boots’ co-business, and innovation in the business model. The company
believes there lies significant scope to enhance the performance of its pharmacies by refreshing and
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differentiating the stores, improving customer experience, delivering proven services to customers and
patients, and introducing new offerings through innovative partnerships.
In late Oct 2015, Walgreens Boots announced its plan to acquire U.S. retail pharmacy chain –
Rite Aid – for a total enterprise value of $17.2 billion, including acquired net debt. The
combination of these two retail giants will allow Walgreens Boots to further expand its business
realm in the U.S. in the long term, where it already enjoys the position of the largest retail drug
store giant. Management expects this buyout to accelerate Walgreens Boots’ strategy by
completing its network; providing a larger and more comprehensive portfolio, with which it will
deploy more knowledge and skill; creating a more comprehensive and strong platform for the
development of the company’s brand presence and overall future growth of its business.
Per one neutral firm, while concerns loom large pertaining to the regulatory approval for the Rite Aid
buyout by Walgreens Boots, it believes this deal should eventually gain clearance. However, the approval
depends upon the number of stores Walgreens Boots will close as there is some degree of overlap
between Rite Aid and Walgreens Boots’ locations in several markets. Nevertheless, most of the firms feel
that the geographic expansion and cost-saving opportunities that this takeover will offer have the
potential to balance this risk.
Jan 19, 2016
Target Price/Valuation
Rating Distribution
Positive
56.3%↑
Neutral
43.7%↓
Negative
0.00%
Avg. Target Price
$94.31↓
Maximum Target
$102.00↓
Minimum Target
$81.00
No. of Analysts with Target price/Total
16/16
Upside from current
18%
Maximum Upside from current
27.6%
Minimum Downside from current
1.3%
Risks to the target price include lower-than-expected growth in the retail business, increased
industry regulation or changes to the existing health care law, or a material loss of business,
weak front-end business compelling the company to take a promotional stance, or inability to
meet the synergy goals.
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Recent Events
On Jan 7, 2016, Walgreens Boots reported fiscal 1Q16 results. Highlights are as follows:
 Walgreens Boots reported adjusted EPS of $1.03 in 1Q16, up 32.1% y/y.
 Revenues in 1Q16 increased 48.5% y/y to $29 billion.
 Guidance: Walgreens Boots now expects to earn adjusted EPS in the $4.30–$4.55 range in FY16,
narrower than the earlier guided band of $4.25–$4.55.
Other Events
Revenue
Walgreens Boots recorded total sales of $29 billion in 1Q16, reflecting an increase of 48.5% y/y; largely
due to the inclusion of Alliance Boots’ consolidated results for 1Q16.
Segments in Detail
Historically, the legacy Walgreens used to report as one segment, which comprised the performance of
Walgreens in the U.S.; its corporate costs and synergies from the Walgreens Boots Alliance
Development joint venture, also known as WBAD; and equity earnings from Alliance Boots on a threemonth lag. Following the combination of Alliance Boots and the legacy Walgreens, Walgreens Boots
eliminated the three-month reporting lag and recast prior period results with no lag.
As Walgreens Boots, management now reports results in three segments: Retail Pharmacy USA, Retail
Pharmacy International, and Pharmaceutical Wholesale.
Retail Pharmacy USA
The Retail Pharmacy USA segment consists of the legacy Walgreens business, which includes the
operation of retail drugstores and convenient care clinics, in addition to providing specialty and infusion
and respiratory pharmacy services. Revenues for this segment are principally derived from the sale of
prescription drugs and a wide assortment of general merchandise, including non-prescription drugs,
beauty products, photo finishing, seasonal merchandise, greeting cards and convenience foods.
In 1Q16, revenues from the Retail Pharmacy USA division, whose principal retail pharmacy brands are
Walgreens and Duane Reade, increased 4.2% y/y to $20.4 billion. Total sales in comparable stores
(those open for at least a year) jumped 5.8% y/y, driven by strong pharmacy volume and mix. Total sales
growth was lower than comparable-store sales primarily due to the sale of Walgreens Boots’ infusion
business and store closures during 2015. Retail comparable store sales dropped 0.6% in 1Q16 due to a
reduction in unprofitable promotions and the transitioning of seasonal items away from holiday
decorations and toward higher quality, giftable items.
Pharmacy sales, which accounted for 68.4% of division sales in 1Q16, climbed 6.7% y/y, while pharmacy
sales in comparable stores increased 9.3%. Management attributed the increase in pharmacy sales in
part to growth in Medicare Part D and greater focus on pharmacy customer care. The division filled 231
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million prescriptions (including immunizations) on a 30-day adjusted basis in 1Q16, reflecting an increase
of 4.1% y/y, even in the face of the y/y 10.7% lower reported incidence of flu across the U.S. (according
to IMS Health). During 1Q16, the company witnessed an increase in comparable-store scripts on account
of its Medicare Part D growth strategy, having recently expanded its market share therein coupled with a
greater focus on customer care.
Prescriptions filled in comparable stores were up 4.7% y/y. For 1Q16, the division’s retail prescription
market share in the U.S., on a 30-day adjusted basis, increased 20 basis points y/y to 19.2%, as reported
by IMS Health. Further, Walgreens Boots’ new U.S. fulfillment agreements with Valeant Pharmaceuticals
International Inc., announced on 15 Dec 2015, are expected to enhance the division’s pharmacy market
share growth as the agreements are rolled out in calendar year 2016.
As of Nov 30, 2015, the division operated 8,192 locations (8,182 drugstores) across all 50 states, the
District of Columbia, Puerto Rico and the US Virgin Islands – reflecting 138 locations (47 stores) lesser
compared to the 1Q15 figure.
Retail Pharmacy International
The Retail Pharmacy International segment includes primarily the legacy Alliance Boots pharmacy-led
health and beauty stores, optical practices, and related contract manufacturing operations. Stores are
located in the UK, Mexico, Chile, Thailand, Norway, Republic of Ireland, The Netherlands and Lithuania.
Revenues for this segment are principally derived from the sale of prescription drugs and retail health,
beauty, toiletries and other consumer products.
Revenues from this division, whose principal retail brands are Boots in the UK, Thailand, Norway, the
Republic of Ireland and The Netherlands; Benavides in Mexico and Ahumada in Chile, grossed $3.5
billion in 1Q16.
As the businesses included in this Retail Pharmacy International division were acquired as part of the
merger with Alliance Boots, no comparable information is included in the Walgreens Boots consolidated
results.
On a pro forma constant-currency basis, comparable pharmacy sales grew 3.8% y/y, driven by good
growth in dispensing and pharmacy services in the U.K. and Mexico. On the other hand, pro forma
constant currency comparable store sales grew 2.2% in 1Q16. Comparable retail sales increased 1.3%
y/y, reflecting strong growth in Ireland.
Comparable pharmacy sales in Boots UK were up 3.5%, primarily driven by additional high-value drugs
dispensed in its hospital pharmacies, higher average volume, higher average item value, and growth in
pharmacy services such as flu vaccinations. Comparable retail sales growth at Boots UK was 80 basis
points in 1Q16, growth coming mainly from Boots.com, albeit at a lower rate than in the previous
quarters.
Moreover, cosmetics were the best performing retail category in the UK, led by a strong performance in
premium, No7, and Liz Earle, which Walgreens Boots acquired in July. In November, the company added
another exciting brand to its portfolio, Sleek MakeUP, which has a young and ethnically diverse customer
base.
Outside the UK, the company delivered particularly strong comparable sales growth in Mexico and in the
Republic of Ireland. At Benavides in Mexico, the company currently has a lower operating margin
business than Boots and aims business expansion therein. Management is also working hard to find
innovative ways to accelerate its store opening program.
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Management had earlier expressed its enthusiasm about the company’s buyout of the award winning
premium skin care brand – Liz Earle Beauty Co. Ltd – from Avon. Notably, Liz Earle is recognized as one
of the leading botanical brands in the UK.
Pharmaceutical Wholesale
The Pharmaceutical Wholesale segment comprises the legacy Alliance Boots pharmaceutical
wholesaling and distribution businesses. Wholesale operations are located in France, UK, Germany,
Turkey, Spain, Russia, The Netherlands, Egypt, Norway, Romania, Czech Republic and Lithuania.
Revenues at the segment are principally derived from wholesaling and distribution of a comprehensive
offering of brand-name pharmaceuticals (including specialty pharmaceutical products) and generic
pharmaceuticals, health and beauty products, home healthcare supplies and equipment, and related
services to pharmacies and other healthcare providers.
Revenues from this division, which mainly operates under the Alliance Healthcare brand, reached $5.8
billion in 1Q16.
Similar to Retail Pharmacy International, Walgreens Boots’ Pharmaceutical Wholesale division was
acquired through the merger with Alliance Boots, and hence, no figures were reported in the comparable
period. However, on a pro forma constant-currency basis and excluding acquisitions and dispositions,
comparable sales increased 3.1% y/y.
Walgreens Boots witnessed strong sales growth in this segment, particularly in Norway, where its
wholesale business won a major new contract (around the start of calendar year 2015). This was slightly
ahead of the company’s estimated market growth, on account of its country wholesale sales. During
1Q16, Walgreens Boots also achieved solid sales growth in Germany and Turkey, two of the division’s
largest markets.
Recent Strategic Developments:
On Nov 10, 2015, Walgreens Boots, in collaboration with MDLIVE, announced an expansion of the
Walgreens mobile app, offering MDLive’s telehealth services to users in 20 additional states, now totaling
25, as well as the launch of an updated telehealth experience within the app, providing better functionality
and integration.
On Nov 5, 2015, Walgreens Boots announced that its Healthcare Clinics will soon transition to the Epic
electronic health record (EHR) platform, to further enhance care coordination among providers, while
also supporting the long-term growth plan for its clinic business. The move to the new EHR, EpicCare,
will begin in early calendar year 2016.
On Nov 5, 2015, Walgreens Boots announced that Walgreens Balance Rewards members can now
seamlessly use their account through Apple Pay, without separately scanning a Balance Rewards card or
barcode. More than 85 million active Balance Rewards members will have the ability to earn and redeem
loyalty points via Apple Pay, the easy, secure and private way to pay.
On Oct 27, 2015, Walgreens Boots announced that it has entered into a definitive agreement with Rite
Aid Corporation, under which Walgreens Boots will acquire all outstanding shares of Rite Aid, a U.S.
retail pharmacy chain, for $9.00 per share in cash, for a total enterprise value of approximately $17.2
billion, including acquired net debt. The purchase price represents a premium of 48 percent to the closing
price per share on 26 Oct 2015, the day before the agreement was signed.
Loyalty Card: On Sep 16, 2012, the legacy Walgreens had launched a complete customer loyalty
program ‘Balance Rewards' to stimulate spending through points and rewards earned by customers. This
program includes over 7,900 legacy Walgreens and Duane Reade stores in the U.S. and offers multichannel access to join the program. At the end of FY14, legacy Walgreens’ Balance Rewards loyalty
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program had 82 million active members. The company had integrated its award winning Paperless
coupons into this program and had nearly 1.5 million people enrolled in Balance Rewards for healthy
choices program.
Outlook: The company continues to expect to reach at least $1.0 billion in combined net synergies in
FY16.
Margins
Walgreens Boots’ gross profit increased 41.7% y/y to $7.50 billion in 1Q16, while adjusted gross profit
improved 41.1% to $7.55 billion. However, per management’s expectation, adjusted gross margin
contracted 130 basis points (bps) to 26%.
Within the Retail Pharmacy USA division, gross margin contracted 30 bps to 27% in 1Q16, on account of
lower pharmacy reimbursement rates, an increase in Medicare Part D prescriptions and the mix of
specialty medications.
The LIFO provision was $33 million in 1Q16 versus $34 million in 1Q15.
Adjusted selling, general and administrative (SG&A) expenses declined 38.6% to $5.8 billion in 1Q16.
Adjusted operating income increased 11.2% to $1.2 billion. Consequently, adjusted operating margin
expanded 20 bps to 5.9%.
Please refer to the Zacks Research Digest spreadsheet on WAG for total forward margin estimates and details.
Earnings per Share
In 1Q16, Walgreens Boots reported adjusted EPS of $1.03, up 32.1% y/y. This improvement was
primarily driven by the full consolidation of Alliance Boots’ operations, increased sales and lower selling,
general and administrative expenses as a percentage of sales in Walgreens Boots’ Retail Pharmacy USA
division and a lower effective income tax rate. However, these positive factors were partially offset by
lower Retail Pharmacy USA gross margins and a higher interest expense.
Including one-time items, Walgreens Boots posted net income of $1.1 billion or $1.01 per share, a
significant improvement of 30.6% or 13.5% respectively, compared to 1Q15. Per management, overall
earnings growth was primarily driven by the cost cutting initiatives recently adopted by Walgreens Boots
and improved adjusted operating income margins.
Outlook: Walgreens Boots has raised the lower end of its earlier provided EPS guidance range for FY16
by $0.05. The company currently expects to earn adjusted EPS in the $4.30–$4.55 band in FY16,
narrower than the earlier guided range of $4.25–$4.55.
This guidance continues to assume no material accretion from Walgreens Boots’ agreement to acquire
Rite Aid, the previously announced suspension of the balance of the $3 billion share buyback program,
continuation of the company’s normal anti-dilutive buyback program relating to stock incentives and no
significant changes in currency exchange rates.
Buoyed by the company’s better-than-expected bottom-line performance and updated EPS outlook, one
of the neutral firms has also raised its FY16 EPS guidance for Walgreens Boots.
Please refer to the Zacks Research Digest spreadsheet on WBA for additional details on EPS forecasts.
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Jan 19, 2016
Analyst
Aparajita Dutta
Content Ed.
Anindita Sinha
No. of brokers reported/Total
brokers
16/16
QCA
Aniruddha Ganguly
Lead Analyst
Urmimala Biswas
Reason for Update
Earnings Update
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