Transcript Document

Ricky Fang, Jacob Stoiber, & Kevin Farshchi
Presented October 30, 2014
Agenda
Investment Thesis
Macroeconomic Overview
Industry Analysis
Walgreen & Its Business
Catalysts & Concerns (SWOT)
Financial Analysis
Valuation
Recommendation
Investment Thesis
 Walgreens Boots Alliance is likely to become the principal retail pharmacy in




the world
Our team is confident that recent financial results, merger valuation, and
strategic initiatives demonstrate Walgreen is an attractive holding in the long
term.
Granted, there is a chance the next few quarters/years may experience some
tough adjustments and potential volatility, we are optimistic that long-term
shareholders have an opportunity for increasing return on invested capital
The recent sales increases in conjunction with a strong balance sheet indicate
that Walgreen is in a solid financial position to create opportunities for growth
through its strategic acquisition of Alliance Boots
In conclusion, if we apply proper valuation and identify mispriced businesses,
the market should agree with us in the long term and price should reflect fair
value.
Transaction History & Current Position
 Original purchase: 1000 shares @ $25/share; Date
purchased: October. 6th. 1999 (Cost basis: $ 25000)
 Action 1: 500 shares sold @ 49.94/share; Date sold:
September 20th, 2006
 Action 2: 200 shares sold @ 60.35/share; Date sold:
November 22nd, 2013
 Current position: 300 shares trading at $62.83/ share as of
October. 29th, 2014 (Cost basis: $18,849)
Macroeconomic Overview
 Booming Domestic Economy
and Weak Economy in Europe
 GDP number: $14.41, 14.96,15.53,16.24,16.8
trillion from 2009-2013 respectively with an
estimate of 17.42 trillion for 2014
 GDP decomposition: Y=C+I+G+NX;
Consumer spending grew for the first time
since 2004.
 Unemployment rate: 9.3%, 9.6%,8.9%,
8.1%, 7.4% in 2009-2013 and 5.9% reported
in Sep. 2014
 Low economic growth rate/ recession
features in Europe: (-4.5%, 2%, 1.6%,0.4%,0.1% GDP growth rate in 2009-2013)
Source:
Source: http://clients1.ibisworld.com/reports/us/bed/default.aspx?bedid=33
Macroeconomic Overview
Projected
Macroeconomic Overview
 Healthcare insurance provider:
private insurance, Medicare &
Medicaid, Affordable Care Act
(Obamacare)
 Percentage of uninsured
Americans dropped from 18%
in 2013 to 13.4% in May 2014.
 Federal funding for Medicare
and Medicaid add up to $ 827.6
billion in 2014 with roughly 4%
annual growth
Pharmacies & Drug Stores
Product Mix
Market Share
Rite Aid Corp
Walgreen
10.6%
6.5%
CVS Caremark
10%
7.0%
Other
31.0%
7.5%
28.4%
8.0%
50.6%
12.0%
4.0%
24.0%
Turk, Sarah. "IBISWorld Industry Report 44611 Pharmacies & Drug Stores in the US." IBIS. N.p., Aug. 2014. Web. Oct. 2014.
<http%3A%2F%2Fclients1.ibisworld.com%2Freports%2Fus%2Findustry%2Fdefault.aspx%3Fentid%3D4620>.
Branded
prescription drugs
Food and
beverages
Non-prescription
drugs
Specialty
prescription drugs
Other
merchandise
Personal health
goods
Generic
prescription drugs
Cosmetics and
toiletries
Industry Analysis- Porter’s Five Forces
Threat of new entrants:
Medium
Threat of Substitutes:
High
Bargaining Power of Buyers:
Medium
Bargaining Power of Suppliers:
Medium
Rivalry among existing Firms:
High
• Rooms for smaller business;
• Industry concentration
• More usage of online-ordering
• Face competition in general merchandise with supermarket
• Relatively for individuals
• High because of the existence of public health insurance and PBM (Prescription Benefits Managers)
• Maintain by being industry giants
• Strong, long-term relationship with suppliers
• Multiple competitors including other drug retail chain, supermarket, independent drug store, online
drug ordering and mail-order drugs
Turk, Sarah. "IBISWorld Industry Report 44611 Pharmacies & Drug Stores in the US." IBIS., Aug. 2014. Web. Oct. 2014.
<http%3A%2F%2Fclients1.ibisworld.com%2Freports%2Fus%2Findustry%2Fdefault.aspx%3Fentid%3D4620>.
Introduction to Walgreens
 Walgreens primarily sells prescription and non-prescription drugs
 The company also sells general merchandise: convenience and fresh foods,
household items, personal care, photofinishing and beauty care.
 Walgreens Co. and subsidiaries are the largest drugstore chain in the US
 As of August 31, 2014 Walgreens operates 8,309 stores and accounted for
net sales of $76.4 billion
 Approximately 76% of the US population is within a 5 mile radius of a
Walgreens store
Source: Walgreen Co., FY14 Form 10 K for the Period Ending August 31, 2014, p. 3, from http://investor.walgreens.com/sec.cfm, accessed October 26, 2014
The Business
 Three main business segments
 Prescription drugs (65% of net sales)
 Non-prescription drugs (25% of net
sales)
 General merchandise (10% of net
sales)
 Distribution pipeline
 Key Supplier: AmerisourceBergen
 Buyers: pharmacy benefit managers
(Express Scripts), private health
systems, public healthcare sector
 GICS classification:
 Sector: Consumer Staples
 Industry: Food and
Staples Retailing
 Sub-Industry: Drug Retail
Source: Walgreen Co., FY14 Form 10 K for the Period Ending August 31, 2014, p. 5, from http://investor.walgreens.com/sec.cfm, accessed October 26, 2014
Management
 Gregory D. Wasson President and CEO
 New executive members from Alliance & Boots: Stefano Pessina (Executive Vice Chairman),
Ornella Barra (president and chief executive of global wholesale and international retail)
 Two members of activist investor Jana Partners LLC will join the board
 Walgreens appointed new CFO Timothy McLevish on August 4. 2014 and he has a history of cost
control and financial discipline
 Management Focus
 Three year “Next Chapter” Plan
 Cost reduction initiative
 Capital Allocation Policy
"Walgreens Board of Directors Exercises Option to Complete Second Step of Strategic Partnership with Alliance Boots and Fully Combine Both Companies, Creating First Global Pharmacy-Led, Health and Wellbeing
Enterprise." Walgreen Co. N.p., 06 Aug. 2014. Web. 29 Oct. 2014. <http://investor.walgreens.com/releasedetail.cfm?ReleaseID=864504>.
Management – key points
1. Moody’s rating downgraded their credit rating of subordinated debt
2. Ex-CFO dispute
3. Concerns for stock repurchases
4. Still need to wait to see how synergies are realized
5. Concerns for new executives: board members for Jana
6. Decision to not complete tax inversion disappointed investors back in
September
Walgreens (NYSE: WAG)
Price: $62.83
Beta: 0.964
Market Cap: 59.712.8 Billion
Shares outstanding 950.4 M
Dividend Yield: 2.15%
EPS: $2.00
52 week high: 76.39
52 week low: 54.86
Data assessed from Bloomberg Terminal
Alliance Boots Acquisition
 On August 2, 2012, Walgreens acquired
a 45% equity stake in Alliance Boots
GmbH
 On August 5, 2014, the Purchase and
Option Agreement was amended to
permit the exercise of the call option
and Walgreen exercised the call
option on August 5, 2014
 The company will have over 11,000 stores
across the US, Asia, and the EU as a
result
Source: Walgreen Co., FY14 Form 10 K for the Period Ending August 31, 2014, p. 10, from http://investor.walgreens.com/sec.cfm, accessed October 26, 2014
Strengths/Catalysts
 Predicted growth of retail and prescriptions sales
based on macro assessment
 Aging population, ACA, and stronger US
economy
 Strong recent financial results
 (Discussed later)
 Partnerships create a global powerhouse
 AmerisourceBergen ten-year distribution
agreement established the world’s largest
buyer of prescription drugs
 Express Scripts, the largest global PBM, will
increase customer base
 Alliance Boots acquisition: cost synergies and
addition to top line in the long term
 Combined synergies across both companies
were approximately $491 million in fiscal 2014
and management estimates fiscal year 2015
combined synergies to be $650 million.
"Walgreens Board of Directors Exercises Option to Complete Second Step of Strategic Partnership with Alliance Boots and Fully Combine Both Companies, Creating First Global Pharmacy-Led, Health and Wellbeing
Enterprise." Walgreen Co. N.p., 06 Aug. 2014. Web. 29 Oct. 2014. <http://investor.walgreens.com/releasedetail.cfm?ReleaseID=864504>.
Risks/Concerns
 Slowdown of discretionary spending will disrupt front-end sales of general merchandise
 Seasonality of business
 Second fiscal quarter has much higher-front end sales due to the cough, cold, and flu season
 Operating leases can be viewed as debt
 The balance sheet does not reflect this liability
 Risk of PBM’s
 Partnership with AmerisourceBergen may not be realized to full potential
 Alliance Boots synergies and revenue stream may not come to fruition
 The goals of this acquisition will take time to achieve
 Exposure to EU: exchange rates, economic recession, government regulation are a few issues
 Dilution
 After the second step transaction, Walgreens shareholders will own a smaller percentage of
Walgreens Boots Alliance common stock than they currently own.
Source: Walgreen Co., FY14 Form 10 K for the Period Ending August 31, 2014, p. 10, from http://investor.walgreens.com/sec.cfm, accessed October 26, 2014
Risks/Concerns
 Slowdown of discretionary spending will disrupt front-end sales of general merchandise
 Seasonality of business
 Operating leases can be viewed as debt
 The balance sheet does not reflect this liability
 Risk of PBM relationships in the future
 Partnership with AmerisourceBergen may not be realized to full potential
 Alliance Boots synergies and revenue stream may not come to fruition
 The goals of this acquisition will take time to achieve
 Exposure to EU: exchange rates, economic recession, government regulation are a few issues
 Dilution
 After the second step transaction, Walgreens shareholders will own a smaller percentage of
Walgreens Boots Alliance common stock than they currently own.
Source: Walgreen Co., FY14 Form 10 K for the Period Ending August 31, 2014, p. 10, from http://investor.walgreens.com/sec.cfm, accessed October 26, 2014
Recent Financial Results
 Sales for September were $6.48 billion for FY 2015, an increase of 9.4%
 Comparable store sales increased by 7.9% during the month.
 Pharmacy sales accounted for 67.8% of total sales, and increased by 14.2%.1
 Fiscal Year 2014 sales increased 5.8 percent to record $76.4 billion;
 Sales for September in FY 2015 increased 9.4% at $6.48 billion, an increase of 9.4%
from $5.82 billion for the same month in fiscal 2014;
 Gross margin decreased to 28.2% in 2014 from 29.2%
 Met fourth quarter earning estimate(Adjusted EPS increased 1.4% to 74%)
1
"Walgreens September Sales Increase 9.4 Percent." Walgreen Co. N.p., 03 Oct. 2014. Web. 29 Oct. 2014. <http://investor.walgreens.com/releasedetail.cfm?ReleaseID=874420>.
Financial Analysis - Liquidity
Current Ratio
Quick Ratio
Liquidity
2010 2011
1.604 1.524
0.611 0.529
Liquidity Ratios
1.800
2012
1.234
0.427
2013
1.337
0.565
2014
1.376
0.693
1.600
1.400
1.200
1.000
0.800
0.600
0.400
0.200
0.000
2010
2011
Current Ratio
2012
2013
Quick Ratio
2014
Financial Analysis - Solvency
Debt/Assets
Interest Coverage
Solvency
2010 2011 2012 2013 2014
0.091 0.088 0.161 0.142 0.121
40.682 61.479 39.364 23.879 26.885
Debt/Assets
Interest Coverage
0.180
70.000
0.160
60.000
0.140
0.120
50.000
0.100
40.000
0.080
30.000
0.060
20.000
0.040
10.000
0.020
0.000
0.000
2010
2011
2012
2013
2014
2010
2011
2012
2013
2014
Financial Analysis - Profitability
Profitability Ratios
35.00%
30.00%
Gross Margin
ROA
ROE
Profitability
2010 2011 2012 2013 2014
28.15% 28.39% 28.40% 29.24% 28.23%
8.13% 10.10% 6.98% 7.11% 5.32%
14.52% 18.28% 11.66% 12.59% 9.44%
25.00%
20.00%
15.00%
10.00%
5.00%
0.00%
2010
2011
Gross Margin
2012
2013
ROA
ROE
2014
Financial Analysis - DuPont
Tax Burden
Interest Burden
DuPont Analysis
2010
2011
0.620
0.632
0.975
0.984
20.00%
18.00%
2012
0.630
0.975
2013
0.629
0.989
2014
0.571
0.848
16.00%
14.00%
12.00%
10.00%
Operating Profit Margin
Asset Turnover
Leverage
ROE
0.051
2.566
1.825
14.52%
0.060
2.629
1.849
18.28%
0.048
2.141
1.835
11.66%
0.055
2.035
1.824
12.59%
0.055
2.055
1.818
9.93%
8.00%
6.00%
4.00%
2.00%
0.00%
2010
2011
2012
ROE
2013
2014
Financial Analysis - Efficiency
A/R Turnover
A/P Turnover
Inventory Turnover
Efficiency
2010
2011
27.518
28.908
14.704
15.007
9.138
8.974
2012
33.056
16.340
10.181
2013
27.438
15.581
10.540
2014
23.739
17.704
12.573
Days Sales Outstanding
(DSO)
13.264
12.626
11.042
13.303
15.376
Days Payable
Outstanding
24.822
24.322
22.338
23.426
20.617
Days Inventory
Outstanding
39.943
40.675
35.851
34.631
29.031
Cash Conversion Cycle
28.385
28.979
24.555
24.508
23.790
Financial Analysis – Joel Greenblatt
Greenblatt Ratios
Joel Greenblatt Ratios
0.350
2010
2011
2012
2013
2014
EBIT/Tangible Assets
0.250
0.307
0.246
0.290
0.305
EBIT/EV
0.049
0.061
0.047
0.053
0.057
0.300
0.250
0.200
0.150
0.100
0.050
0.000
2010
2011
2012
EBIT/Tangible Assets
2013
EBIT/EV
2014
Discount Rate
Returns
n
µ
σ
60
1.376%
0.083
WAG Annualized Return
17.82%
CAPM Approach
Rf
Beta
MRP
E[r] Equity
2.37%
0.964
7.29%
9.398%
Blended E[R]
Cost of Debt
Total Interest Expense
Total Debt
Cost of Debt
Marginal Tax Rate
Tax Effected Cost of Debt
WACC
Business Risk Premium
Discount Rate
Risk Free Rate
2.37%
15.713%
156.00
4,510.00
3.46%
37%
2.18%
7.87%
1%
8.87%
Capital Structure Summary
Total Debt
Total Common Equity
28,024.0
20,457.0
Total Minority Interest
Total Capital
104.0
48,585.0
57.7%
42.1%
0.2%
100.0%
Assumptions
Select a Case:
Base Case
Revenue Assumptions
FY 2015
Revenue Growth
FY 2016
FY 2017
FY 2018
FY 2019
Boom Case
5.00%
9.00%
9.00%
7.00%
5.00%
3.0%
7.0%
7.0%
5.0%
3.0%
Base Case
3.0%
7.0%
7.0%
5.0%
3.0%
29.5%
32.0%
35.0%
35.0%
32.0%
Bust Case
1.0%
5.0%
5.0%
3.0%
1.0%
22.5%
22.5%
22.5%
22.5%
22.5%
3.0%
3.5%
4.0%
4.5%
5.0%
Tax Rate
37.0%
37.0%
37.0%
37.0%
37.0%
Depreciation
10.0%
10.0%
10.0%
10.0%
10.0%
2.0%
1.7%
1.7%
1.7%
1.7%
44.4%
44.4%
44.4%
44.4%
44.4%
Gross Profit Margin
SG&A as a % of Sales
Interest Expense/Operating Income
Capital Expenditures
Total Assets as a % of Revenue
Discounted Cash Flow Valuation
FCF Build - WAG
EBIT
Less: Taxes
Less: Capex
Less: Changes in NWC
Plus: D&A
Unlevered FCF
$5,507.86
1,976.77
1,573.68
1,983.99
1,477.41
1,450.83
$7,998.20
2,855.76
1,431.26
242.13
1,580.83
5,049.88
FCF Build - BOOTS
EBIT
Less: Taxes
Less: CAPEX
Less: Changes in NWC
Plus: D&A
Unlevered FCF
1,929.69
8.90
463.71
(45.41)
625.56
2,128.05
2,064.77
9.52
496.17
(45.83)
669.35
2,274.25
2,209.30
10.19
530.90
(46.25)
716.21
2,430.66
8.87%
8.87%
1
1,332.59
3,287.21
2
4,260.30
6,178.96
Terminal Value Assumptions
Discount Rate (WACC + premium)
Terminal Value WAG
Terminal Value (WAG + BOOTS)
Discount Period (t)
PV of FCF's (WAG)
PV of FCF's (WAG + BOOTS)
PV of FCF's
Terminal
Value
Enterprise
Equity Value Value
Net Debt
DSO
$11,260.63 $11,823.66
3,999.78 4,177.89
1,531.45 1,608.02
259.08
198.01
1,691.48 1,776.06
7,161.81 7,615.80
$9,255.56
3,253.33
1,656.26
124.75
1,829.34
6,050.57
9,255.56
3,253.33
1,829.34
0
1,829.34
6,002.23
2,319.77
10.70
557.45
(46.67)
752.02
2,550.30
2,389.36
11.02
574.17
(47.09)
774.58
2,625.84
2,389.36
11.02
774.58
0
774.58
2,378.34
8.87%
8.87%
8.87%
3
5,549.60
7,433.08
4
5,420.43
7,235.56
5
3,955.43
5,672.01
$/Share
Perpetuity Method (WAG ONLY)
20,518.34
68,814.68
51,844.02
89,333.02
37,489.01
965.2
$
53.71
Perpetuity Method (WAG + BOOTS)
50,325.17
86,862.87
81,612.53
137,188.04
55,575.51
965.2
$
84.56
3%
8.87%
105,264.94
27,608.08
5
68,814.68
18,048.19
Comparables Valuation
Company Name
CVS Health Corporation
Rite Aid Corporation
Wal-Mart Stores Inc.
Express Scripts Holding Company
Walgreen Co.
High
Low
Median
Mean
High
Low
Median
Mean
Weighted Average
Enterprise Value
Less: Total Debt
Plus: Cash
Equity Value
Total Shares Outstanding
Intrinsic Value/Share
Weight
70%
20%
8%
2%
100%
TEV
EBITDA
110493.0 10429.0
10532.6
1157.9
299142.9 35585.0
69332.1
5802.7
EBIT
8545.0
750.1
26590.0
3726.0
Revenue
132053.0
25943.3
480479.0
100355.9
TEV/EBITDA
10.6x
9.1x
8.4x
11.9x
TEV/EBIT
12.9x
14.0x
11.3x
18.6x
TEV/Revenue
0.8x
0.4x
0.6x
0.7x
62507.7
5141.0
3936.0
76392.0
12.2x
15.9x
0.8x
299142.9
10532.6
89912.6
122375.1
35585.0
1157.9
8115.9
13243.7
26590.0
750.1
6135.5
9902.8
480479.0
25943.3
116204.5
184707.8
11.9x
8.4x
9.8x
10.0x
18.6x
11.3x
13.5x
14.2x
0.8x
0.4x
0.7x
0.6x
TEV/EBITDA
11.9x
8.4x
9.8x
10.0x
10.1x
TEV/EBIT
18.6x
11.3x
13.5x
14.2x
13.1x
TEV/Revenue
0.8x
0.4x
0.6x
0.7x
0.7x
EV/EBITDA
52165.9
4,510
2,646
50,302
950
$52.93
EV/EBIT
51687.6
4,510
2,646
49,824
950
$52.42
EV/REVENUE
55807.0
4,510
2,646
53,943
950
$56.76
Average Value/Share
Median Value/Share
$54.04
$52.93
Price Targets
 DCF: WAG + BOOTS = $84.56 (23.26% return)
 DCF: WAG only =$53.71
 Comps (average) = $54.04
Our Recommendation
HOLD