With a forward dividend yield in excess of 9%, Walgreens Boots Alliance (NASDAQ: WBA) definitely qualifies as a stock with a mouth-wateringly high annual cash return. But with its shares down by 45% over the past 12 months, it’s clear that this isn’t a stock to buy on a lark.
Is Walgreens still worth buying for its tempting annual payout despite its poor performance recently? Probably not, and here’s why.
At the crux of Walgreens’ riskiness as a dividend stock is its ongoing struggle to diversify beyond its core retail pharmacy business, which has long experienced sluggish growth. As most investors know, diversification into new segments can be a wonderful thing when it works, as it can create opportunities for synergies while also cushioning against certain headwinds. But spinning up new product lines costs a lot of money, and new ventures can take quite some time to become profitable.
Walgreens’ foray into providing primary healthcare, which follows in the footsteps of its main competitor, CVS Health, hasn’t gone exactly as planned. While its clinics brought in nearly $8 billion in revenue in the fourth quarter, management frankly admits that the segment’s growth was marred by inefficiencies. It’ll be closing 60 of its unprofitable clinics as a result. If Walgreens wants to maintain its current capital allocation strategy, including its dividend, that might not be enough.
Over the last 10 years, the company’s dividend only grew by 52%. Its payout ratio is only 38% of its earnings at the moment, which seems to suggest that its dividend payments are sustainable even in light of the difficulties with the new healthcare segment. But, that doesn’t take into account the issue of its profitability, which has become spotty over the last three years.
It’s no coincidence that three years ago is roughly when its diversification push started, led by the July 2020 announcement of its intent to open up to 700 clinics co-located at its pharmacies. In its fiscal fourth quarter of this year, it reported a net loss of $180 million, meaning that it needed to draw from its cash reserves to pay shareholders.
On that front, the company is close to scraping the bottom of the barrel. It currently has $739 million in cash and equivalents, but over the last year it paid out roughly $415 million per quarter in dividends. Furthermore, its trailing-12-month free cash flow (FCF) is only $141 million. Something needs to bridge the gap between the outlays that shareholders are expecting and the financial resources Walgreens actually has.
Leaning on debt has helped a bit so far, but it might not be tenable for much longer. Presently, Walgreens’ debt load of $35 billion looms larger than the company’s equity. Though it’s made some progress in de-leveraging over the last few years, it still can’t afford to stop. That means management will need to find money somewhere else to avoid cutting the dividend. Broad cost-cutting is on the table. So is liquidation of major investments.
On Nov. 9, the business announced that it had sold some of its shares of the medical distributor Cencora, formerly known as AmerisourceBergen, for $674 million. In August, it also sold close to $2 billion worth of Amerisource’s shares, making a total of three divestments this year alone when considering another earlier sale. Investments in other companies were liquidated earlier in the year. At the pace the company is offloading its holdings, it might run out soon enough, leaving it in an even deeper pickle.
You probably should not buy this stock with the idea that its dividend will continue to rise. It’s possible that the dividend will be cut sometime in the next few years if circumstances don’t improve. Either way, until its costs and finances are rectified to the market’s satisfaction, it is likely that its shares will continue to fall.
But Walgreens isn’t destined to collapse, and it’s shaking up its management team to give the company a new direction. This year alone, it secured a new chief executive officer, chief information officer, and board member. It’s also currently looking for a new chief financial officer. There are already a few signs that the new leaders are going to try to make some major changes, hopefully for the better.
Keep an eye on Walgreens, and check back in a year or so if you’re still interested in it as a dividend investment. If things are looking up, its dividend yield will probably be a bit lower, but the payout might be more sustainable, too.
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