Brick & Mortar Meltdown: Dog of the Dow on 3rd Day in the Dow.
It was a melancholic but symptomatic day for the US economy when a once mighty industrial company that manufactures big complex things, such as diesel-electric locomotives, jet engines, and power-plant turbines, was kicked off the Dow after 111 years and replaced by a retailer that sells mostly imported drugs, imported plastic stuff, and packaged junk food. That was Tuesday morning when GE (GE) was replaced by Walgreens (WBA).
Today it became even more symptomatic for the US economy when Walgreens announced declining same stores sales – as part of the brick-and-mortar meltdown – and a $10 billion share buyback program to soothe rattled investors’ nerves, with money it would have to borrow, and its shares, in the morning of their third day on the Dow, plunged 10%.
Walgreens Boots Alliance is the largest “retail pharmacy, health and daily living destination” in the US and Europe, as it says, with 13,200 stores in 11 countries. Back in 2012, it acquired a 45% stake in Swiss pharmacy giant Alliance Boots and in 2014 bought the remainder for a total cost in cash and shares of $10.7 billion.
In its third quarter, ended May 31, Walgreens completed the acquisition of all 1,932 Rite Aid stores, which inflated the revenue comparisons with the same quarter a year ago. Hence the importance of same-store sales (or “comparable” store sales), which only measure revenues at stores that Walgreens operated for at least a year.
Walgreen’s US retail sales rose 5.2% in the quarter compared to the quarter a year ago. But same-store sales dropped 3.8%, “reflecting continued focus on profitability,” as it says elegantly. In plain text, prices are high to fatten up profit margins, but consumers aren’t going for it.
This includes pharmacy sales – accounting for 72.5% of US retail sales – which jumped 19% from a year ago, “primarily due to higher prescription volume from the acquisition of Rite Aid stores.” It sure helps a lot to buy nearly 2,000 stores from a competitor.
But same-store pharmacy sales were flat from a year ago, “as brand inflation was offset by reimbursement pressure and the impact of generics.” Brand inflation… hmm.
International retail sales increased 6.6% year-over-year “due to favorable currency exchange rates,” but fell 2.1% on a constant currency basis. And on that basis, same-store sales fell 1.4%.
Total sales, thanks to the inclusion of the Rite Aid Stores, rose 14% to $34.3 billion in the quarter, and net income rose 15.5% to $1.34 billion.
A pile of debt: Walgreens has $1.8 billion in cash, but it’s all borrowed cash: Among its $41.7 billion in total liabilities is $15 billion in debt.
A big blob of “assets” with zero tangible value: There are two types of “assets” on its balance sheet that have no tangible value:
- “Goodwill” of $17.1 billion, a result of paying more for acquisitions than fair value. It can sit on the balance sheet for years. But eventually, some or all is written off, and thus becomes an expense.
- “Intangible assets” of $12.1 billion, which will be amortized and thus becomes an expense over time.
This amounts to $29.2 billion that will eventually turn into an expense. They account for about 40% of its total assets ($70 billion).
Negative tangible equity: Total assets minus total liabilities produces “equity,” of which it has a respectable-sounding $28.5 billion. But take out goodwill and intangible assets, and the resulting tangible equity is negative -$730 million.
It’s in this scenario that Walgreens announced today that it would raise its quarterly dividend by 10% to 44 cents per share. With 995 million shares outstanding at the end of the quarter, the dividend payments at the announced rate would amount to a cash outflow of $1.8 billion a year. Dividends are the classic way with which profitable companies reward shareholders – and they should.
But then Financial Engineering: Walgreens also announced today that its board of directors has authorized a share repurchase program “for up to $10 billion.”
Share buybacks is pure financial engineering. The purpose of the announcement today of the share buyback plan was to keep shares from plunging further. As the company actually buys its shares in the future, it will prop up its shares. It also reduces the number of shares outstanding, thus increasing the crucial metric of earnings per share that otherwise might not look so good, even as shareholder equity gets hollowed out further.
Walgreens is rated two notches above junk by Moody’s (Baa2), Fitch (BBB), and Standard & Poor’s (BBB). It will have to borrow most or all of the money for these share buybacks. This will increase its debt and drive tangible equity deeper into the negative. It makes the company more fragile and more leveraged in an environment of rising interest rates and tightening credit, and less able to deal with the challenges ahead.
At the top of these challenges is the shift in pharmacy sales from brick-and-mortar sales to online sales. This is embodied by the appearance of Amazon (AMZN) as a competitor. It has been trying to muscle into this space for a while. But today it announced that it is acquiring an online pharmacy (PillPack). And things will go from there.
But hey, GE too was mastering share buybacks — $44 billion just from 2015 though 2017 — until even share buybacks couldn’t paper over its problems any longer.
The PE firms involved in the Toys ‘R’ Us collapse come under “intense scrutiny” by the pension funds that have long fed them. But this too shall pass. Read… In 3 Days, the Last Toys ‘R’ Us Stores Die. And PE Firms Behind it?
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I thought Amazon’s entry into the pharmacy arena was a major reason the stock dropped????
There’s going to be a new joke in the future.
What’s a public company? It’s one where the shares outstanding in the market is exactly 1 share.
Let’s see SSS are flat to down. Where is the biggest cost line that we can cut? Is it the 4 or 5 guys/gals in the white coats in the glass cages who each earn $100K per year putting pills in bottles and occasionally answering a customer question or two? Yepper. And AMZN knows it. They’re just about to wreck the entire distribution chain, and starting with automating the pharmacist right out of a job.
I don’t know the business, but I always thought that prescriptions had to be prepared by a licensed pharmacist?
PillPack is licensed in 49 states. That was one of the most attractive aspects of the deal to AMZN, and made AMZN more willing to do the deal, and (perhaps) pay more than WMT.
I think they will simply reduce the numbers of pharmacist’s needed by moving pharmacists from stores to their main warehouses and make a conveyer belt of moving prescriptions to check.
Eliminating pharmacists will require states to change their laws and many pharmacy schools in each state will be powerful enough to prevent this elimination, especially with the cost of a pharmacy degree. A pharmacist’s license is state regulated not federal regulation so it will not be easy to totally eliminate the pharmacist.
AMZ may eliminate AmerisourceBergen, Cardinal, and McKesson, who are the middle between the drug companies and pharmacies and that would disrupt the dutribution chain as you say. But then AMZ will have to deal with Big Pharma and that may get interesting because they are a few rungs up from AMZ.
Are the leveraged buy-out Boys going to “save” Walgreens too?
“A house with negative assets and positive liabilities shall not stand”
There’s a Walgreens within easy walking distance of my house.
Fairly new store, but I have never, ever, EVER been in the place when it has been busy. Most of the time, I’m among the handful of customers in the place.
And did I mention that there’s another Walgreens that’s, oh, about a mile away as the crow flies?
In my suburb there’s a Walgreens about 500 yards from a Rite-Aid. Looks like some more bricks-and-mortar creative destruction in the works.
The Rite-Aid was previously a Thrifty until they were bought out, and CVS bought out Longs Drugs. If this keeps up we’ll be left with one monopoly bricks-and-mortar drugstore chain in the country.
In my town, we had a Walgreen’s right downtown. It was often called “The Zoo” because it, and the corner it was on, was full of interesting characters. One fine day one of said characters tried to get the security guard’s gun away from him and was shot and killed. Good riddance, one less.
It’s closed now. I’m not sure if it simply wasn’t profitable (“shrinkage” er, stealing, cuts down on profits) or whether management decided the violent crime rate there was just too high and it was only a matter of time before there was some big, lawsuit-causing, shootout.
Walgreens doesn’t do itself any favors not selling booze, but in the case of the one downtown it’s probably better they didn’t sell booze. There are enough hole in the wall booze-selling bodegas and our ghetto-ass Safeway to get your drink on.
Overpriced drugs and even more overpriced junk food in my former location corner store. It is amazing how much drug price difference even with WMart pharmacy. CVS, Walgreen and alike, I wouldn’t touch with a 10 ft pole. Compare the cost of med in US and Europe does not work in the US favor.
Walgreen’s in SF does sell booze – lots of wine. There’s the main flagship store downtown which is quite luxe (I’ve never been in it, but have read that it is). Perhaps the smaller stores don’t sell booze. The prices at Walgreen’s are way too high, and I’ve noticed many items have gone up lately. In Sf, they have a monopoly.
You are spot on your observations on Walgreens having vagrants and bums hanging around. I had to get meds from one for hospice and avoided going there at night. Junk people hanging out and stopping in to get alcohol. Saw the same at another store in another neighborhood. Won’t go near them.
Oh, I forgot to mention the crazies. Last time I went into my nearly deserted neighborhood Walgreens, there was a guy going in and out of the store, and he was having a vigorous discussion with someone who was a figment of his imagination.
One of the employees told him to get out, and if he came in one more time, she would call the cops. He took off a-running.
“The purpose of the announcement today of the share buyback plan was to keep shares from plunging further. As the company actually buys its shares in the future, it will prop up its shares.”
This is an interesting tidbit describing how share buybacks increasingly support prices in the stock market. There are however four quarterly blackout periods a year, lasting about four-weeks each, when share buybacks cannot be dynamically used by a company to prop up its share price.
A blackout period is an SEC rule to prevent insider trading by restricting a company ( and employees ) from trading its shares during the time period around an earnings release. Most publicly traded companies establish blackout periods that restrict trading just prior to the quarter end, and immediately after the company reports. This typically lasts from two weeks prior to quarter end through 48 hours after earnings are released. This does not mean that companies are completely restricted from making share buybacks during a blackout period. During this blackout period, the SEC Rule 10b5-1 allows companies to set up a daily buyback plan that automatically purchases a predefined number of shares, over a predefined range ( minimum to maximum ) of market prices. Share buybacks during the blackout period, however, cannot deviate from these predefined purchases or move to support their companies share price if markets fall. So every year there are quarterly buyback blackouts from approximately 3/15 – 4/15, 6/15 – 7/15, 9/15 – 10/15, and 12/15 – 1/15.
We’re currently in a blackout period, which probably is the reason for higher volatility and some steep market drops since June 15th.
‘Goodwill’ is a term that is hard to come to terms with.
With Walgreens, is the concept that someone needing a drug will not shop around, check prices etc. but just go to WG because of loyalty?
I think brand loyalty extends to manufacturers but a retailer?
It looks like this intangible ‘goodwill’ is just a way of making the balance sheet look prettier.
And 17 billion is a lot of lipstick.
Yes ‘goodwill’ is just another piece of financial chicanery that sits in the hall of smoke and mirrors and exists to paint a picture which is expedient.
A bit like ‘imputed rent’ in GDP figures, or conveniently ignoring the cost of putting a roof over your head in inflation figures etc. Just a deceptive and mendacious way of making things looking rosy until you can:
a) get re-elected
b) get away with the cash
c) a and b.
In the accounting world we call it a “plug”.
PS: just saw on CNN: largest med insurance crackdown in US history. 600 charged including doctors and pharmacies. Over prescribing and in some cases billing for drugs not delivered.
Effect on WG? and others: we’ll see.
I wasn’t in the least bit melancholy seeing GE kicked out of the Dow.
The brand inflation in the big box drug stores is what keeps me out of them. I used to go monthly to buy blades until they became incredibly expensive. When we started buying blades online, we also started buying other drug store items in the supermarket, which had better prices. I rarely go to a big box drug store now, maybe once or twice a year.
Thanks to the upcoming combined forces of Bezos, Buffett & Dimon (BB& D), dismemberment — ooops, creative destruction — will be the talk of big-pharma & health/hospitals…especially supply-side. And that’s, what, 17% of US GDP? …PJS
They better shape up before they get kicked out of the DOW!
Yeah well,
I opted to pay more for my rX’s to keep my local mom&pop pharmacy in business.
F*ck big pharma.
I use a mom and pop pharmacy after using CVS for years.
Prices about half. And so much more friendly.
Should have switched years ago…
“I opted to pay more for my rX’s to keep my local mom&pop pharmacy in business.
F*ck big pharma.”
pssst….your local mom%pop pharmacy sells meds made by big pharma
Although the theme of the argument seems cogent, the technical descriptions of goodwill and intangible assets aren’t correct.
Technical description?? I don’t see a technical description, neither in the article nor so far in the comments.
So now that Amazon is officially in the pharmacy business things get interesting. AWS is already into EMR, they just hired a physician who was running a novel multi-site clinic to join the company and apparently Alexa is getting HIPPA approved as she will interface between physicians and at some point in the future, between patients and physicians. Some wonder if pharmacies are in Whole Foods future and don’t forget Amazon is expanding their own fleet of delivery vans at breakneck speed. There is also the consortium set up between them, JPM and Berkshire Hathaway to address the crisis of cost in the healthcare system. I wonder if the first order of business is to attack the nations largest health problem, diabetes & obesity. Things are certainly evolving and getting interesting. Amazon has the muscle to set up their own PBM and for Prime members, maybe big savings on Rx products.
Loaded up with debt and decides to privatize itself via buybacks to keep the short-term stock price from falling off a cliff.
I’ll bet the directors will be dumping like crazy once the buybacks start.
The next thing that’s coming when buybacks can no longer do the job (or become too expensive as IRs rise) of course is – just like Japan – the [much-hated] state stepping to buy not only bonds but stocks too in order to keep the plates spinning.
Surely the human race can come up with a better way of ordering its business than this debt-ridden, destructive farce?
Brick and mortar retailer with a lot of debt? These can continue to drop over time and be dead money, like Rite Aid before Walgreens acquired them. Stay away.
So based on this insight, good time to short Walgreen, maybe a long short position?
Wolf,
Contrary to the article title, it seems to me your analysis makes a very well reasoned case for a self inflicted wound, rather than an Amazon inflicted one. I’ve never understood how failing retail companies could “acquire” their way into profitability. It certainly didn’t work for Sears who acquired Landsend, NTB, and Western Auto (that I am aware of) which it then more or less ran into the ground the same way it was running its original business into the ground.
First, I should disclose that I own 100 shares of WAG (Walgreen Boots); have held for a while, so still ahead on the shares. Must consider selling while ahead; company debt is worrisome. Amazon competition of course also worrisome.
My Google query came up with a Reuters article (6/28) which is short and emphasizes a point I wondered about in reading your post, Wolf: What about the PBMs ? (the “Pharmacy Benefits Managers”, remember them ? They were exciting new middlemen (save everybody money) in the healthcare space, some 15 or 20 years ago). Their business is at risk here, and as Amazon becomes more and more a middleman, itself, they seem as much or more at risk as are WAG and the other retailers.
For the data bank: like alicat, above, I have chosen to give my business to my local Drug Store. You might be surprised how much research it takes each year to review Medicare’s latest Part D (Drug) changes, the middleman coverage (in my case, Express Scripts), and the local Drug Store prices/role in coverage. In my case, I found 2 years ago that I could save about $100 per year by moving my prescriptions to Walmart. I like Walmart for reasons I gave here at WS, months ago, but keeping local businesses going is important to me.
Walgreen’s is not a big box store, and to some extent they fill the role of the old variety store- browse greeting cards, etc.; probably the prosperous middle class enjoys a quick 15 minutes in a Walgreen’s more than in a Family Dollar (but wait, we don’t have much prosperous middle class left anymore). However, WAG’s profits are primarily from the drug trade.
The Bezos Buffett JP Morgan alliance to contain/reduce the cost of health care is -yes- laughable. IMHO, at least. Putting my money where my mouth is, I will close now to get back to my daily exercise, BTW, …….doesn’t Buffett/Berkshire Hathaway own lotsa Coke shares ?
Anyway, thx to all Commenters chipping in with humor and info; and as always, thx, Wolf.
In terms of Pharmacy Benefits Managers, now everyone hates them. They’re blamed for surging drug prices, drug price manipulations, the opioid crisis…. Google something like:
Pharmacy Benefits Managers scandal scandal
and:
Pharmacy Benefits Managers lawsuit
The CEO’s of these companys have been adding facility costs over the years because in my state CVS built numerous stores next to Walgreens or Eckerd’s drug stores. Then CVS buys Eckerd’s. Then CVS owned twice the amount of stores close to Walgreen’s stores. And some Walgreen’s have closed or some CVS. Create all those buildings and those costs and now many sit empty. Mail order will be the future of most of the prescription drugs. Insurance companies will demand it or you will pay more. Amazon will compete in this market. Although, with this crazy structure in drug pricing, Amazon will not be the bully they are in other markets. Cardinal, AmerisourceBergen and McKesson will be bullies and cut-throat also. They avoided violations in the opioid prescription crisis with political connections. They knew many stores were receiving excess narcotics order quantities. I also fault the DEA. They also get the quantities ordered per store.
I can see the next crisis in auto parts stores. O’Reilly’s is building next to Autozone or Advance Auto. In one block we have all three and with today’s cars the shade tree mechanic is disappearing. The younger generation does not want to get their hands oily so no changing oil or air filters or antifreeze or spark plugs. So why all the need to build this auto part infrastructure where the future is declining. It is crazy. Get ready PE. Here is your next prey.
I deal with both Walgreens and CVS stores in my work. The major differences I have noticed between the two chains is 1) Walgreens stores are usually significantly larger, and 2) Walgreens always has several more employees on the clock at any given time than does CVS.
CVS seems like they run a tighter operation cost-wise than Walgreens.
Maybe Walgreen’s will be replaced on the Dow by a more legitimate company…like Twitter.
My family purchases all of our non-compunding prescriptions at our local grocery store. We are both on medicare and so far co-pays have typically been non-existent or quite small – with a couple of exceptions for somewhat rarely prescribed medications like Mepron – which was the same (very high) co-pay at our local Walmart when we checked. This has been very convenient as we are in and out of this grocery store several times a week and they also have “no wait” flu shot and other vaccine injection service. I don’t see that Amazon (that we use extensively) pharmacy service would make a difference for us.
Thought I owed it to all to follow up on my remarks re Buffett (and/or Berkshire Hathaway) to search for number of shares of Coke (KO) owned by them: investopedia (spring 2018) reports that Berkshire Hathaway owns 400 million shares of Coke, just a bit short of 10%.
Ah, that explains the recent new Coke ads: “share a Coke with someone”, which I read as a tacit admission by some at Coke that the number of high, fast carbohydrates in Coca Cola are gaining recognition by many in healthcare, (along with other high fast carbs in the Standard American Diet (SAD)), as perhaps problematic in the increasing incidence of the Metabolic Syndrome in the U.S. population.
Well, anyway, I’m not on a mission to ban any drink. Anyone who can tolerate such drinks- and Buffett says that he can- is welcome to them.
Back to the Amazon Berkshire Hathaway JP Morgan alliance to fix American healthcare (more better cheaper), it’s -yes- laughable. Can you say “conflicts of interests” ?
Some reasons we stopped buying at Walgreen’s: Third world clerks, horrible music, cheap Chinese chemical junk for sale and look alike stores with zero character.
But CVS is even worse! They managed to screw up every prescription we ever brought them, the staff are rude Filipinas who heavily scrutinize and insult older Americans who might return something defective and what mystifies me, the stores are half empty with ten foot wide aisles.
We love our local small chain, Pharmaca or Jack’s in San Anselmo, the last independent drug store hereabouts.