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.