WBA - Walgreens Boots Alliance

[dwy000]

Smaller chains and mom & pop stores are disappearing faster than Sears stores. They just cant compete effectively against the big chains (of which there are now just 2) and the pharmacies within grocery or Walmart stores.  You increasingly need to be a preferred pharmacy for insurers or payers.  In addition you saw from the past quarter how they are getting squeezed by PBM's - and that was CVS and Walgreens, imagine the impact for smaller players.

 

Amazon has its work cut out for it. Surprisingly, the proportion of scripts filled in store has been increasing relative to mail over the past few years.  Also, pharmacy margins have been shrinking.  Theres definitely a play there for Amazon given the size of the market but I dont think it's going to be nearly as easy or fast as it's made out to be.  If they struggled against Autozone, competing in one of the most regulated industries where relationships with PBM's and players is key will be tough. 

 

The question about the CEO is a really good one. Those are massive shoes to fill.

[Okonomen]

However, AMZN doesn't even have to compete in drugs to mess up the industry I guess, as a considerable share of WBA/CVS' revenues stem from non-drugs? Such items must be more prone to e.g. online competition. I think people in here refer to these items as "front store items" ?

[Spekulatius]

Yes, the main protection is regulation and convenience. I personally don’t like to pull up in a Wal Mart parking lot and deal with going in a huge store to get a prescription. AMZN is very good at offering convenience though.

 

WBA has been fighting PBM in the past and mostly been losing. It is interesting, but in the last CC (and before too), they note that they don’t want to own a PBM and think it is going to be disintermediated and reduced to a software layer. I think this might be true.

 

CVS/Aetna or integrated players are a threat too, but CVS is neither very good in retail, nor is Setna been good in insurance, so I doubt the two combined will be a center of excellence. I do like the integrated approach when done right - Kaiser HMO is an example of that (from a customer perspective).

 

WBA wants rejigger their store like Boots runs them, with less emphasis on the convenience store aspects and more on beauty. That’s why there are a lot of boots excess running the US now. I think they are quite mindful that the US and Europe are different.

 

Walgreen stores are better run than CVS on average. The smaller pharmacies have trouble to offer the online confidence features that the larger chains do. That’s probably a big issue for the younger folks that do everything online first.

[KCLarkin]

...CVS is neither very good in retail...

 

On what basis? CVS seems better than WBA USA on gross margins, market share, etc.

 

[StubbleJumper]

However, AMZN doesn't even have to compete in drugs to mess up the industry I guess, as a considerable share of WBA/CVS' revenues stem from non-drugs? Such items must be more prone to e.g. online competition. I think people in here refer to these items as "front store items" ?

 

 

Pharmacies have never been competitive on "front of store items."  My general rule of thumb is that merchandise from a pharmacy tends to be about 30% overpriced.  For 20 years you have been better off to buy most of those items from WalMart (kleenex, toilet paper, razor blades, underarm, shampoo, etc).  So who has been buying that stuff at the pharmacy despite the obvious lack of price competitiveness?  People who are not savvy shoppers, or people who seek convenience (if I only urgently need a new stick of underarm, do I really want to fight the crowds at Walmart just to save $0.60?).

 

The people who have been buying the obviously overpriced front of store items for the past 10 or 20 years probably will not switch to Amazon because that requires even more forward planning and organization than making a trip to WalMart.

 

 

SJ

[dwy000]

Last year front-of-pharmacy for CVS was 25% of pharmacy profits.  Same store sales up slightly.  Note that private label products made up 25% of those front of pharmacy sales too.

[kab60]

Pretty bad set of results as well as guidance: https://seekingalpha.com/pr/17462618-walgreens-boots-alliance-reports-fiscal-2019-second-quarter-results

[Spekulatius]

Pretty bad set of results as well as guidance: https://seekingalpha.com/pr/17462618-walgreens-boots-alliance-reports-fiscal-2019-second-quarter-results

 

Ouch! Yes, results stink. I expected some pressure on margins but not that much. Mr Market been correct on that one. Sold a good amount of my shares premarket - when then thesis changes I need to revisit.

[gjangal]

I ve been wrong so far  on this one also. Prime example of how operating leverage kills on the downside if you have declining/flat revenue or no same store sales growth.

 

I think they are positioning the firm for low to no revenue growth. ROIC is good for a retail company but growth matters too.

[Gregmal]

The concerns here and with CVS to me mirror a lot of the sentiment around AXP in early 2016. Different problems, but largely the same unfounded fears and sentiment. The environment may be changing, but these guys and maybe a couple others will be around to shift with it.

[dwy000]

I may need to rethink my view that Walgreens is a better retailer than CVS.  In 4Q CVS had same store sales growth of 0.5% in front of store.  Walgreens got crushed.  Now that included Boots in the UK which had horrible results (-8% I think) but still, CVS seems to be outperforming where they usually fall behind Walgreens.

[Spekulatius]

The concerns here and with CVS to me mirror a lot of the sentiment around AXP in early 2016. Different problems, but largely the same unfounded fears and sentiment. The environment may be changing, but these guys and maybe a couple others will be around to shift with it.

 

I agree on this. I think  Pharma sector stocks, wholesalers and some drug stocks got pretty cheap. I sold out most of my WBA, because the thesis is broken and I thought that -6% pre market is actually OK to sell for what looked like a pretty sucky result. I may shift to CVS or something else. I think the sector will come back.

[Viking]

Not good that they are using debt to fund aggressive share buybacks. Trying to get a read on how good and how shareholder friendly management is; my crystal ball is getting more murky and my spidey senses are tingling (not in a positive way).

 

Crazy how some of these iconic companies (with outstanding long term track records) start underperforming for years and years. Easy to see how some investors get fooled. Quality of managment is critically important to understand.

[frommi]

Crazy how some of these iconic companies (with outstanding long term track records) start underperforming for years and years. Easy to see how some investors get fooled. Quality of managment is critically important to understand.

 

I don`t think the problems WBA face have anything to do with management and all to do with the problems the whole healthcare sector currently has.

 

Some quotes from the call:

I think, as James said in his prepared remarks, this is a very heavy quarter for reimbursement pressure, and we expect that to be not the normal going forward.

And I think as you look forward to the second half, the reimbursement pressure will subside because there is this skew to the first half.

 

The impact of the FEP contract as material as well, because year-to-date, it’s around 140 basis points or 150 basis points. The specialty business will still grow very quickly, but the negative impact will tail off down to 30 basis points. So, there will be quite a material change in the trajectory of the gross margin change year-on-year.

But as I said, we won’t be we won’t have this FEP contract next year.

 

Is the worst already behind us?

[mwtorock]

Crazy how some of these iconic companies (with outstanding long term track records) start underperforming for years and years. Easy to see how some investors get fooled. Quality of managment is critically important to understand.

 

I don`t think the problems WBA face have anything to do with management and all to do with the problems the whole healthcare sector currently has.

 

Some quotes from the call:

I think, as James said in his prepared remarks, this is a very heavy quarter for reimbursement pressure, and we expect that to be not the normal going forward.

And I think as you look forward to the second half, the reimbursement pressure will subside because there is this skew to the first half.

 

The impact of the FEP contract as material as well, because year-to-date, it’s around 140 basis points or 150 basis points. The specialty business will still grow very quickly, but the negative impact will tail off down to 30 basis points. So, there will be quite a material change in the trajectory of the gross margin change year-on-year.

But as I said, we won’t be we won’t have this FEP contract next year.

 

Is the worst already behind us?

 

Not until we see results for the next couple of quarters :p But i think the shares are cheap enough to take a look at again.

[gjangal]

i bought a few more lots. My last buy for this name . expecting low to mid teens total return from here

[Spekulatius]

i bought a few more lots. My last buy for this name . expecting low to mid teens total return from here

 

I sold 90% of my shares , so I will have to wait a month to avoid wash sales, if I can make sense of the whole situation by then. This was an example where it’s turned out to be good to sell, before everybody else did (before market open). The stock looks quite cheap. It’s hard to believe that there isn’t value in this sector somewhere.

 

[Cigarbutt]

Secular competitive pressures will continue and cyclical "reimbursement" pressures are expected given the evolving PBM landscape. Longer term perspective suggests that WBA will continue to adapt and grow profitably albeit not in a straight line.

 

Where are we now?

-Opinion: the Rite-Aid acquisition was not value accretive and this may be showing up in the numbers as it may be difficult to improve operating results to the Walgreens' level. IMO this will be slowly digested + or - divested.

-From my perspective, leverage is way too high but given where interest rates are, the institutional imperative may just be too strong. No existential threat but a drag for some time.

-From the capital allocation point of view, the very large share buybacks done in the last few years were IMO a poor use of capital. (Sidenote: from a relative set of opportunity point of view, retrospectively, it made sense to use debt and buy stock but...)

 

Despite the above, given the large and enduring (although variable) free cashflows to come, it is reasonable to expect that WBA will perform better than the S&P 500 for the foreseeable future.

 

For fun, I've taken a long-term look at what happened to WBA' share price over time vs the S&P 500. (I have held pharmacy retailers during that period)

Since April 3rd              CAGR of stock price      performance vs S&P 500

    1995                                13.0%                              ++

    1997                                7.4%                                  +

    1999                                3.6%                              neutral

    2007                                1.9%                                  --

    2009                                5.7%                                  --

 

The 1990's was a good period to buy as well in 2008-9 (but there were other opportunities then and the stock went ahead of itself in 2015-7).WBA's profile has changed from organic growth to acquisitions and to growing debt, payout and capital return to shareholders but with today as a reference point and assuming that capital allocation skills reverse to the mean (consolidate operations, pay down debt) while continuing to enjoy favorable demographic tailwinds and tolerable vagaries of the retail pharmacy market, I would say that WBA will outperform the S&P 500 for the foreseeable future.   

 

[Spekulatius]

^ good summary by Cigarbutt. I was surprised by the deterioration in profitability in this quarter , which wasn’t signaled ahead. WBA was already cutting a lot of costs and yet it doesn’t seem they can do fast enough to get already of the ever falling margins.

 

I agree they should stop the buybacks for now. The Ride Aid acquisition  is crimping FCF right now and they shouldn’t add to the debt before they return to normal FCF. I think their leverage is Ok for the time being, but they definitely need to watch it. The Ride Aid acquisition will work out, if they can indeed move most patient from their 700 store closures to existing locations.

 

They were dismissive of PBM in their last CC in 2018, but it seem that at least for the time being, these PBM are eating their margins.

[JRM]

^ good summary by Cigarbutt. I was surprised by the deterioration in profitability in this quarter , which wasn’t signaled ahead. WBA was already cutting a lot of costs and yet it doesn’t seem they can do fast enough to get already of the ever falling margins.

 

I agree they should stop the buybacks for now. The Ride Aid acquisition  is crimping FCF right now and they shouldn’t add to the debt before they return to normal FCF. I think their leverage is Ok for the time being, but they definitely need to watch it. The Ride Aid acquisition will work out, if they can indeed move most patient from their 700 store closures to existing locations.

 

They were dismissive of PBM in their last CC in 2018, but it seem that at least for the time being, these PBM are eating their margins.

 

PBMs are the problem that Trump and congress are going after in their battle against drug prices.  In my opinion Walgreens is well positioned because they don't own a PBM.

[dwy000]

^ good summary by Cigarbutt. I was surprised by the deterioration in profitability in this quarter , which wasn’t signaled ahead. WBA was already cutting a lot of costs and yet it doesn’t seem they can do fast enough to get already of the ever falling margins.

 

I agree they should stop the buybacks for now. The Ride Aid acquisition  is crimping FCF right now and they shouldn’t add to the debt before they return to normal FCF. I think their leverage is Ok for the time being, but they definitely need to watch it. The Ride Aid acquisition will work out, if they can indeed move most patient from their 700 store closures to existing locations.

 

They were dismissive of PBM in their last CC in 2018, but it seem that at least for the time being, these PBM are eating their margins.

 

PBMs are the problem that Trump and congress are going after in their battle against drug prices.  In my opinion Walgreens is well positioned because they don't own a PBM.

 

I don't think PBM's are the problem.  Well, they are for Walgreens/CVS but not in relation to drug prices.  Their role is to drive down costs and squeezing drug stores  through lower reimbursement rates is one way to do it. They aren't going to get much public pushback for driving fill costs down!  And at this point, almost all of the rebates negotiated by PBM's are returned dollar for dollar back to the payers. 

 

In my view the issue is twofold:  one is the high and growing gross-to-net drug price bubble (https://www.drugchannels.net/2019/04/the-gross-to-net-bubble-reached-record.html).  In reality, drug prices have been growing at low single digits for years.  Brand name drugs have been up less than 2% for the past 2 years, and if you include generics, total drug spend in 2017 was up only 0.4% (https://www.drugchannels.net/2019/01/drug-prices-are-not-skyrocketingtheyre.html).  Second is the increasing use of specialty drugs (which you don't get at your local CVS or Walgreens) which have massive cost and little generic competition (due to their personalized or specialty nature).

 

 

PBM's get targetted by everyone as the bad guy but I think CVS was absolutely right to acquire one.  They are only the enemy of the local drug chain because they drive down cost.

 

[JRM]

In theory PBMs should be driving down drug prices for consumers.  That hasn't been happening according to many industry journals and articles I've followed.  I think a proper functioning PBM could be the solution, though.

[dwy000]

PBM's are middlemen and their profits are tiny compared to total drug spend.  If total drug spend is flat but consumers aren't reaping the benefits the question might be what payers are doing with the rebates. 

[DooDiligence]

PBM's are middlemen and their profits are tiny compared to total drug spend.  If total drug spend is flat but consumers aren't reaping the benefits the question might be what payers are doing with the rebates.

 

I agree, PBM's have taken the heat over this but the fact is that their clients (self insured employers, for example) are the one's who decide whether or not to pass the rebate on to their employees.

[Spekulatius]

PBM's are middlemen and their profits are tiny compared to total drug spend.  If total drug spend is flat but consumers aren't reaping the benefits the question might be what payers are doing with the rebates.

 

I agree, PBM's have taken the heat over this but the fact is that their clients (self insured employers, for example) are the one's who decide whether or not to pass the rebate on to their employees.

 

The argument with respect to the PBM is that they are working with the drug manufacturers to increase the list prices, while at the same time increasing the discounts to the customer (from which they get a cut or at least it makes it appear that they do something) so the cost to the customer rises less. Just look at the drug channel link up thread  - drug list price increase by 6% and prices to consumers by 1.5% - how can this be?

 

I think the whole system lives of opaqueness- everybody pays a different price for the same product.