Retail

2 Huge Thumbs-Up for Walgreens Boots Alliance, With Rite Aid Hanging in the Balance

Jon C. Ogg

Published: September 1, 2016 11:50 am

Last Updated: January 13, 2020 4:00 am

It is not that often that one company gets two huge thumbs-up from analysts in the same week when there is not an earnings report. That is the case for Walgreens Boots Alliance Inc. (NASDAQ: WBA) during the week of September 2, 2016. Merrill Lynch reaffirmed its position in the firm’s Top 10 U.S. Ideas List for the third quarter, and Credit Suisse added it the firm’s prized U.S. Focus List. This also has key implications for Rite Aid Corp. (NYSE: RAD) due to the pending merger.

What matters here is how far Walgreens has come, and that it may perhaps avoid much of the post-Brexit woes compared to other companies that operate in the United States and in Britain. Another issue is that massive size with a market cap of $88 billion. If the analysts following Walgreens are correct, this could be among the next mega-cap stocks to reach a market value of $100 billion.

The more pertinent of the two key analyst calls came from Credit Suisse. After all, this was a new addition, and it sees more implied upside to the price target. Credit Suisse had an Outperform rating, and the firm’s Robert Willoughby has a $95 price target.

Credit Suisse sees Walgreens standing to benefit in the near term from continuing cost and working capital management opportunities. An imminent clarity on the Rite Aid deal and further expansion of its payor relationships are also seen as upside opportunities. Credit Suisse sees its potential risks coming from reimbursement challenges, weak front-end sales trends and a failure to successfully close the Rite Aid deal.

Walgreens is currently trading at just 8.7 times Credit Suisse’s 2017 EBITDA estimate. That is below the average multiple of 9.5 times for the pharmaceutical supply channel. Its $95 price target implies that shares can trade at 10.1 times EBITDA with an improved economic profit opportunity.

As far as the Rite Aid exposure, Credit Suisse’s report said:

The successful closing of the Rite Aid acquisition in the second half of 2016 brings meaningful revenue growth, cost cutting, and cash flow opportunities to drive Walgreens Boots’ shares materially higher. Downside from the deal not closing as expected is limited, in our view, given new and potentially more preferred pharmacy network agreements with the leading PBMs, contributions sooner than expected from the early AmerisourceBergen warrant exercise, and ongoing capital deployment.

Merrill Lynch’s Steven Valiquette has a Buy rating on Walgreens, with a $94 price objective. Valiquette sees Walgreens as an attractive vehicle for total return, noting the company’s history of annual dividend hikes. His report for the Top 10 Ideas list said:

The company is levered to the growing healthcare market in both the US and international markets. Walgreens Boots Alliance is also in the midst of change with the Alliance Boots management team reducing costs in the legacy Walgreens operations and placing greater focus on higher margin products. Walgreens Boots Alliance is also pursuing a deal with Rite Aid, which could see the company achieve significant synergies through cost cuts and efficiencies in procurement. In the short-term, we expect the company to also benefit from generic pricing erosion in the US marketplace. Walgreens Boots Alliajnce also just added another major PBM alliance with the announcement of a long-term strategic alliance with Prime Therapeutics, which is the 4th largest PBM in the US market.

Merrill Lynch’s investment rationale from a reiterated Buy rating on August 29 said:

In conjunction with our view of the slowdown in generic inflation and a movement towards generic deflation, we believe drug chains and dispensers of drugs are poised to benefit from this deflationary trend. We see the planned RAD deal as being a good move by WBA and see significant benefits that the combined organization will have in reducing the overall cost structure of the businesses.

As for the Merrill Lynch valuation:

Our 17 times P/E multiple is a 10% premium to the current trading range of comparable companies. We assign a higher Price/Earnings (P/E) multiple due to greater cost cutting efficiencies that can be achieved within the Retail US segment and greater expansion of private label offerings. Risks to our price objective are continued reimbursement rate pressures, FTC blockage of the planned Rite Aid deal, and softness within the front end retail business.

Prime Therapeutics is owned by a consortium 14 private Blue Cross Blue Shield plans. The recently announced alliance will be a new model that aligns pharmacy, PBM and health plans in an effort to coordinate patient care, improve health care outcomes and deliver cost of care opportunities. Walgreens has over 8,000 retail locations and Prime Therapeutics has some 22 million members.

Shares of Walgreens were trading up 0.6% at $81.23 on Thursday, with a consensus analyst price target of $91.98 and in a 52-week range of $71.50 to $95.74.

Rite Aid shares are closer to $7.55 and continue to trade well below its $9.00 per share cash buyout offer. That deal has been approved by shareholders, but the regulatory review remains an unresolved issue. Investors should understand that a merger arbitrage spread indicating almost 20% gains if the deal were to close should be viewed as a red flag, with many investors not expecting the deal to close successfully. That being said, Rite Aid shares remain in limbo until more clarity is seen on this issue.

Rite Aid’s shares have a consensus analyst price target of $8.88, and the 52-week range is $5.88 to $8.74. Other key research on the Rite Aid deal and the valuation from recent months were as follows:

• S&P’s $9 valuation.
• Credit Suisse sees further upside above the deal.

At the time of the merger, 24/7 Wall St. opined that Rite Aid could have demanded a higher buyout price. Still, that was then and a lot has happened since. Stay tuned.