Walgreens Boots Alliance (WBA) - Get Report is an attractive investment ahead of third quarter earnings, Jefferies analysts say, thanks to its free cash flow and willingness to participate in the pharmacy benefit manager market.
The investment firm assumed coverage of Walgreens, a retail pharmacy with locations in the U.S. and Europe with a buy rating and a price target of $95 per share Monday, Oct. 17. This is just ahead of Walgreens' third quarter earnings call, which will be held on Oct. 20.
Walgreens, which recently agreed to acquire Rite Aid RAD for $17.2 billion, was trading at $78.34 per share Monday morning, up 1.6% from Friday's closing price.
According to Jefferies analyst Brian Tanquilut, what's particularly compelling about Walgreens is its free cash flow yield, which is currently around 8%. The company was able to significantly increase this yield by cutting administrative costs earlier in 2016. Given its acquisition of Rite Aid, however, it's hard to compare ratios year-over-year, Tanquilut noted.
Other positives for Walgreens include its willingness to partner with pharmacy benefit managers (PBMs) and other programs designed to manage costs for purposes of insurance reimbursement. This was a rarity before CVS Corp. (CVS) - Get Report acquired Caremark in 2007 for $21 billion in an all-stock deal. The deal was considered revolutionary given that no retail pharmacy had paired with a PBM prior to it. Since then, though, retail pharmacies have been forced to reconsider involvement in the PBM market and have slowly begun entering the market.
Walgreens has plunged into the PBM market since then, announcing a partnership with TRICARE, the military's PBM and Prime Therapeutics, earlier in 2016. Combined, the two PBMs have approximately 30 million members, which brings in about 76 million more prescriptions in 2017.
"As the company seeks to further grow its pharmacy market share and provide a traffic boost to its front-store operations, we expect Walgreens to pursue new contracting and partnership opportunities with other PBMs, although admittedly, there are few scaled PBMs left that Walgreens could join forces with," Tanquilut wrote in a note.
Tanquilut believes that Walgreens' acquisition of Rite Aid (RAD) - Get Report will pass muster before the Department of Justice when it comes to antitrust issues. He that divestitures and prescription file sales will likely be enough to appease regulators without making the deal unacceptable to investors.
"We believe the longer-term opportunity with Rite Aid lies in improving the chain's productivity levels," Tanquilut wrote. "This may take capital investment, re-bannering in some markets and a lot of patience."
Rite Aid struggled thanks to high financial leverage and constrained capital lending, according to Tanquilut, but could make a turnaround if given the proper tools.
Walgreens will likely have to divest somewhere between 500 stores and 1,000 stores to win approval of its its Rite Aid acquisition, Tanquilut predicted. If regulators approve, CVS could be a major buyer of at least some of the stores, especially those located in Washington, Michigan, Colorado and Wisconsin. However, given CVS' concentration in the retail pharmacy market, some analysts see that move as unlikely.
Rite Aid could also sell prescription files to a pre-existing pharmacy or grocery chain, then simply shut down the remaining stores, Tanquilut noted.
Worst case scenario, if the deal is quashed by the federal government, Walgreens could likely still come out on top.
"Even if the merger with Rite Aid ultimately ends up being blocked by the FTC, Walgreens should be able to reallocate capital to share buybacks in order to defend the stock price," Tanquilut wrote.
Walgreens has a market cap of $84.83 billion.
Walgreens is a portfolio company of Jim Cramer's Action Alerts Plus.