Walgreens Boots Alliance (NASDAQ:WBA) offers an attractive yield, and under normal circumstances, their retail model, which incorporates the supermarket concept of cross selling beauty products and other high-margin items, manages to command exceptional margins within the sector. However, COVID-19 has changed all that, and accelerated the transition of e-pharmacy as the working model for providing medicines and health products. The one thing that might bring customers back into pharmacies is vaccines and other basic health services. Although that could perhaps drive sales in less medicine oriented categories, the pharmacy is burdened by the fact that the sick and vulnerable go there, and few want to linger lest they catch or spread disease which in these times prove fatal in conjunction with other immune-compromising conditions. Without being directly invested in their own health-services concept, they have less to gain what might be a vaccine surge that will be a tailwind to the business. Finally, being less cash generative than competitors puts them at a disadvantage in this market push. The dividend is nice, but we are skeptical of a long-term payoff.
Weaker Retail Concept
Against competitors like CVS (NYSE:CVS), Walgreens does not have analysts’ favor. While often analyst bullishness can be a counter-indicator for a stock, in this case it reflects equity researchers acknowledging that Walgreens is more levered to pharmacy foot traffic to sell non-medical products. Having leaned heavily into the format more akin to supermarkets, they are already backtracking to emulate the concept that CVS happens to have going into this new normal, where pharmacy foot traffic is lagging other retail locations. Assuming a robust resumption in foot traffic would be speculative, and the high-margin ancillary products and services provided like photos and cosmetics upon which the margins rely will not recover with much conviction, we believe strategies levered to convenience traffic could be permanently impaired as people’s shopping behaviors evolve, and this is the strategy Walgreens employs.
Less To Gain With A Vaccine Surge
We have already seen that Walgreens is advancing a pilot with a format for more essential medical products. In addition to essential products, pharmacy visits could be driven by what will likely be a surge in vaccines as people immunize against diseases that could compromise their health and make them vulnerable to COVID-19. Co-circulation is a legitimate concern of the WHO’s, and demand for influenza vaccines has already seen boosts. Walgreens has been quite attentive to the opportunity of providing chronic disease management and basic healthcare services at their locations with several hundred of in-shop clinics in operation.
Although this initiative is being expanded in partnership with VillageMD to match CVS’ HealthHUB initiative, it comes in tandem with the shut-down of a lot of self-operated locations in deference to external operators. Even though this might be a successful initiative in restoring foot traffic and creating cross-selling opportunities of their higher margin products, they are not invested in the clinical services themselves. Meanwhile, CVS is continuing to greenfield its HealthHUB concept, which offers similar cross-selling opportunities in addition to cross-sales and membership benefits with Aetna, while also being fully invested in the clinical and other alternative health services that will be offered on location.
They Don’t Have the Optionality
Another issue for Walgreens relative to competitors is their capacity to generate cash. CVS cash generation is much higher thanks to Aetna, and this cash is going to be an important element to tackle the e-pharmacy future without putting too much pressure on the business. E-pharmacy companies are growing at massive rates, and this will bring the currently low penetration up. But in order to deliver into the increasing demand as e-scripts and the online pharmacy become more accepted, capacity will have to be built. Shop Apotheke, a European e-pharmacy, is making substantial investments into logistics to be able to serve the DACH region and wider Europe.
Walgreens and its competitors for the American e-pharmacy opportunity may not need to invest so heavily, as their locations could act as a decentralized warehouse network, and indeed they are able to sustain fast delivery times nationally. Nonetheless, infrastructure will still need to be developed. Currently e-pharmacy penetration remains low, and in order to service customers if adoption and penetration continues to increase, more money will need to be invested. Since the online pharmacy concept is still in its infancy, and the market will likely feature winner-take-all dynamics that could end up in the hands of one of many well-capitalized competitors eyeing the sector, it’s still a business option for each of the entrants. Cash enables the companies to exercise that business option, and of the companies involved, Walgreens is already in a worse cash and financing position than both CVS, which is generating more cash flow despite higher debt-levels, and Amazon (NASDAQ:AMZN) whose capitalization opportunities are monumental given its valuation.
Overall, Looks Rough
We think that Walgreens has few advantages. Its retail concept is being damaged by the new COVID-19 normal while also being encroached on by Amazon. Moreover, they are less cash generative and more limited in their ability to raise capital compared to competitors, meaning that the value of their e-pharmacy business option, which could branch into all sorts of markets like telehealth, is lower. Moreover, they are less levered to one of the few things that will bring customers back into pharmacies, vaccines and preliminary health services. Overall, Walgreens is an alright company, but in a market that is under threat long term and already struck by potentially permanent COVID-19 related changes in consumer behavior, it is definitely more risky than less exposed competitors like CVS. We think that the dividend is attractive, but it’s a trap that is certainly not worth the risk when even CVS pays a reasonable dividend. We are not convinced Walgreens will ever pay off.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.