The Walgreen Co. Snapshot
Board: Value Hounds
As there have been a couple of threads on Walgreen recently on this board, why not a third?
Given a quick glance Walgreen does seem to be headed towards value territory given its shrinking P/E ratio and its predictable business — relatively speaking. But, given a closer look it might not be so compelling, and, at the moment the market doesn't seem to think so — is it wrong or right?
In spite of what Value Line might say, and record, Walgreen's earnings growth has been sluggish for several years. Given a "great recession" that's hardly surprising. However, WAG's been taking in more money in revenues every year at a steady clip. Unfortunately, this growth hasn't matched reported earnings growth.
The obvious question is why? The first place to look, I suppose, would be margins. Since '07 their net margin has been slowly contracting every year, up until the last quarter when it expanded a little, but it's about 10% lower than its ten year average ending in '09.
Logically, shrinking margins would affect return on capital and yes, that's shrunk too by two or three percentage points if you exclude the great recession. Long term debt doesn't help returns on capital either and up until 2008 Walgreen didn't have any, but starting in '08 it started to accumulate and is close to $2.4 billion today. Not such a big deal as this is roughly equal to one years reported earnings, but, no debt is better than a couple of $ billions worth.
Revenue has increased so predictably and evenly not because of greater systemic efficiency, that is: increased same store sales, but basically because every year Walgreen opens new stores and every year the store count increases. The store count has increased at 8% a year over the last ten; that's just more than doubling. Can the number of Walgreen stores double again over the next ten years? Doubtful. Before saturation point stores will begin to cannibalize each others sales.
Walgreen has been upping its dividend consistently since '02, but the yield at current prices isn't enough to tempt most investors to buy the stock for its dividend while they patiently wait things out. Presently the dividend yield is just over 2%.
The current P/E ratio, although it has contracted over the decade really isn't out of whack with the earnings growth the company has shown over the last five years. Margins and returns on capital have yet to turn around sufficiently to match, let alone best, those reported before the recession. If this stock is a good buy now then it has to be a successful turnaround story, even though the large ship doesn't have to swing that far, it does have to swing.
Value Line predicts that earnings, margins, and returns on equity and capital will pick up to at least pre-recession levels, and Walgreen will prove to be a safe and sound investment. Time will tell, but I'm not so sure it's a sure thing. The margin of safety in today's stock price is a little too narrow to be irresistibly tempted.