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Ricky Fang, Jacob Stoiber, & Kevin Farshchi Presented October 30, 2014.

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Presentation on theme: "Ricky Fang, Jacob Stoiber, & Kevin Farshchi Presented October 30, 2014."— Presentation transcript:

1 Ricky Fang, Jacob Stoiber, & Kevin Farshchi Presented October 30, 2014

2 Investment ThesisMacroeconomic OverviewIndustry AnalysisWalgreen & Its BusinessCatalysts & Concerns (SWOT)Financial AnalysisValuationRecommendation Agenda

3 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.

4 Transaction History & Current Position Original purchase: 1000 $25/share; Date purchased: October. 6th (Cost basis: $ 25000) Action 1: 500 shares 49.94/share; Date sold: September 20th, 2006 Action 2: 200 shares 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)

5 Macroeconomic Overview Booming Domestic Economy and Weak Economy in Europe GDP number: $14.41, 14.96,15.53,16.24,16.8 trillion from respectively with an estimate of trillion for 2014 GDP decomposition: Y=C+I+G+NX; Consumer spending grew for the first time since Unemployment rate: 9.3%, 9.6%,8.9%, 8.1%, 7.4% in and 5.9% reported in Sep Low economic growth rate/ recession features in Europe: (-4.5%, 2%, 1.6%,- 0.4%,0.1% GDP growth rate in ) Source: Source:

6 Macroeconomic Overview Projected

7 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 Federal funding for Medicare and Medicaid add up to $ billion in 2014 with roughly 4% annual growth

8 Pharmacies & Drug Stores Turk, Sarah. "IBISWorld Industry Report Pharmacies & Drug Stores in the US." IBIS. N.p., Aug Web. Oct

9 Industry Analysis- Porter’s Five Forces Rooms for smaller business; Industry concentration Threat of new entrants: Medium More usage of online-ordering Face competition in general merchandise with supermarket Threat of Substitutes: High Relatively for individuals High because of the existence of public health insurance and PBM (Prescription Benefits Managers) Bargaining Power of Buyers: Medium Maintain by being industry giants Strong, long-term relationship with suppliers Bargaining Power of Suppliers: Medium Multiple competitors including other drug retail chain, supermarket, independent drug store, online drug ordering and mail-order drugs Rivalry among existing Firms: High Turk, Sarah. "IBISWorld Industry Report Pharmacies & Drug Stores in the US." IBIS., Aug Web. Oct

10 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 accessed October 26, 2014

11 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 Source: Walgreen Co., FY14 Form 10 K for the Period Ending August 31, 2014, p. 5, from accessed October 26, 2014 GICS classification: Sector: Consumer Staples Industry: Food and Staples Retailing Sub-Industry: Drug Retail

12 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 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 Web. 29 Oct

13 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

14 Walgreens (NYSE: WAG) Price: $62.83 Beta: Market Cap: Billion Shares outstanding M Dividend Yield: 2.15% EPS: $ week high: week low: Data assessed from Bloomberg Terminal

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17 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 accessed October 26, 2014

18 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 Web. 29 Oct

19 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 accessed October 26, 2014

20 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 accessed October 26, 2014

21 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 Web. 29 Oct

22 Financial Analysis - Liquidity Liquidity Current Ratio Quick Ratio

23 Financial Analysis - Solvency Solvency Debt/Assets Interest Coverage

24 Financial Analysis - Profitability Profitability Gross Margin28.15%28.39%28.40%29.24%28.23% ROA8.13%10.10%6.98%7.11%5.32% ROE14.52%18.28%11.66%12.59%9.44%

25 Financial Analysis - DuPont DuPont Analysis Tax Burden Interest Burden Operating Profit Margin Asset Turnover Leverage ROE14.52%18.28%11.66%12.59%9.93%

26 Financial Analysis - Efficiency Efficiency A/R Turnover A/P Turnover Inventory Turnover Days Sales Outstanding (DSO) Days Payable Outstanding Days Inventory Outstanding Cash Conversion Cycle

27 Financial Analysis – Joel Greenblatt Joel Greenblatt Ratios EBIT/Tangible Assets EBIT/EV

28 Discount Rate Returns n60Risk Free Rate 2.37% µ1.376% σ0.083 WAG Annualized Return17.82% CAPM Approach Rf2.37% Beta0.964 MRP7.29% E[r] Equity9.398% Blended E[R]15.713% Cost of Debt Capital Structure Summary Total Interest Expense Total Debt 28, % Total Debt4, Total Common Equity 20, % Cost of Debt3.46% Total Minority Interest % Marginal Tax Rate37% Total Capital 48, % Tax Effected Cost of Debt2.18% WACC7.87% Business Risk Premium1% Discount Rate8.87%

29 Assumptions Select a Case:Base Case Revenue Assumptions FY 2015FY 2016FY 2017FY 2018FY 2019Boom Case5.00%9.00% 7.00%5.00% Revenue Growth3.0%7.0% 5.0%3.0%Base Case3.0%7.0% 5.0%3.0% Gross Profit Margin29.5%32.0%35.0% 32.0%Bust Case1.0%5.0% 3.0%1.0% SG&A as a % of Sales 22.5% Interest Expense/Operating Income3.0%3.5%4.0%4.5%5.0% Tax Rate37.0% Depreciation10.0% Capital Expenditures2.0%1.7% Total Assets as a % of Revenue44.4%

30 Discounted Cash Flow Valuation FCF Build - WAG EBIT $5,507.86$7,998.20$11,260.63$11,823.66$9, , Less: Taxes 1, , , , , Less: Capex 1, , , , , , Less: Changes in NWC 1, Plus: D&A 1, , , , , Unlevered FCF 1, , , , , , FCF Build - BOOTS EBIT 1, , , , , Less: Taxes Less: CAPEX Less: Changes in NWC (45.41)(45.83)(46.25)(46.67)(47.09)0 Plus: D&A Unlevered FCF 2, , , , , , Terminal Value Assumptions 3% Discount Rate (WACC + premium) 8.87% Terminal Value WAG 105, Terminal Value (WAG + BOOTS) 27, Discount Period (t) PV of FCF's (WAG) 1, , , , , , PV of FCF's (WAG + BOOTS) 3, , , , , , PV of FCF's Terminal ValueEquity Value Enterprise ValueNet DebtDSO$/Share Perpetuity Method (WAG ONLY) 20, , , , , $ Perpetuity Method (WAG + BOOTS) 50, , , , , $ 84.56

31 Comparables Valuation Company NameWeightTEVEBITDAEBITRevenueTEV/EBITDATEV/EBITTEV/Revenue CVS Health Corporation70% x12.9x0.8x Rite Aid Corporation20% x14.0x0.4x Wal-Mart Stores Inc.8% x11.3x0.6x Express Scripts Holding Company2% x18.6x0.7x 100% Walgreen Co x15.9x0.8x High x18.6x0.8x Low x11.3x0.4x Median x13.5x0.7x Mean x14.2x0.6x TEV/EBITDATEV/EBITTEV/Revenue High11.9x18.6x0.8x Low8.4x11.3x0.4x Median9.8x13.5x0.6x Mean10.0x14.2x0.7x Weighted Average10.1x13.1x0.7x EV/EBITDAEV/EBITEV/REVENUE Enterprise Value Less: Total Debt4,510 Plus: Cash2,646 Equity Value50,30249,82453,943 Total Shares Outstanding950 Intrinsic Value/Share$52.93$52.42$56.76 Average Value/Share $54.04 Median Value/Share $52.93

32 Price Targets DCF: WAG + BOOTS = $84.56 (23.26% return) DCF: WAG only =$53.71 Comps (average) = $54.04

33 Our Recommendation HOLD


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