A Cheap Stock for Patient Investors
Justin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Walgreen Co. (NYSE: WAG) was recommended by Oscar Schafer in the latest Barron’s Roundtable. I have been watching this stock for the past couple of years as it continues to get cheaper and cheaper. The stock broke above $50 a share in 2006 and now resides at $32.63 as of Monday. I agree with Oscar’s recommendation that now is an ideal time to begin accumulating shares in a great company.
I agree wholeheartedly with Oscar’s quote, “The situation is reaching the point of maximum uncertainty,” in regards to the squabble with Express Scripts (NASDAQ: ESRX). Things are seemingly tougher on the company with Express Scripts buying Medco Health Solutions and moving into a dominant position with roughly 35% control of pharmaceutical spending, assuming regulatory approval is granted for the deal. Walgreen has more than 8,000 stores and I think that is too much weight for Express Scripts to thrive in their absence. And obviously Walgreen doesn’t want to lose access to one-third of the pharmaceutical prescription market. They will have to come to an agreement.
Compelling valuation
The valuation on Walgreen is simply compelling and at these levels long-term investors should be rewarded. The company has transitioned from a high growth model to a profitability model, and with it the stock price has suffered. The company added more than 1,000 stores in 2008, but less than 300 in 2011. A moderation in square footage growth and deceleration in same-store sales has pushed the price-to-earnings ratio all the way down to 12x. That is not much higher than during the worst of the Global Financial Crisis when it hit 10x. The price-to-book and EV/EBITDA are also at or near all-time lows.
The reduced store growth has caused a noteworthy decline in capex and subsequently a significant increase in free cash flow. Free cash flow (operating cash flow less capex) oscillated around the breakeven line throughout the '90s. It was negative in 2001, but has steadily grown toward $2.5 billion. The company has a robust FCF yield of 8.1%. That is well ahead of many consumer staple companies, such as Procter & Gamble, which boast FCF yields under 5%.
The stock was never known for its dividend, but a 22% growth rate over the last five years and a steady compression in the stock price has resulted in a dividend yield of 2.7%. While I never get too enamored with the dividend yield, it is nice when it both elevated and growing.
Patience will be rewarded
The Express Scripts haggle produces an ideal time for patient, long-term investors to gain exposure to a company expected to continue producing high single-digit EPS growth in the coming years. The secular theme for prescription usage is well known by investors, but nonetheless it is real and should provide a steady floor to the stock price. There is no reason the stock can’t trade on par with the more well known, steady cash producers such as Procter & Gamble and Pepsi. Many of these stocks are trading at 16-17x price-to-earnings. Putting that multiple on Walgreen would add an immediate 30% to the stock price.
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