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Can Walgreens Continue to Grow in 2020?

Walgreens Boots Alliance (NASDAQ: WBA) released fiscal 2020 first-quarter results at the beginning of January. Missing both revenue and earnings-per-share estimates, the company disappointed investors, decreasing the share price by 7%.

The company continues to predict flat growth for 2020 even after the soft quarter, which is due to three factors that have been weighing the company down over the last year and will continue to plague the company in 2020.

Image source: Getty Images.

Competitive pressures

Amazon.com (NASDAQ: AMZN) and CVS Health (NYSE: CVS), in addition to local pharmacies, are turning up the pressure on Walgreens -- specifically surrounding the U.S. and international retail pharmacy business segments, which make up 84.6% of Walgreens' revenue.

Amazon's 2018 acquisition of PillPack for $753 million is an industry disrupter. The company focuses on convenience by providing an at-home prescription delivery, eliminating the need to wait in line for prescriptions and refills. This free service the massive 100 million Amazon Prime customers aside from the co-payment is a threat to every pharmacy.

Walgreens has partnered with Microsoft for seven years to integrate the cloud and provide customers with instant access to healthcare records, offering convenience and increasing efficiency at each location. This cloud adoption will allow healthcare providers, insurers, and pharmacies to access a customer's data, putting Walgreens closer to PillPack's business model and serving 88 million active Walgreens Balance Rewards members.

Providing next-day prescription delivery for $4.99 by partnering with FedEx, Walgreens is slowly heading in the right direction. However, the IT infrastructure, customer adoption, and competition from a behemoth company like Amazon will put pressure on Walgreens in 2020.

Lower reimbursement rates from insurers

The pressure is increasing for the Walgreens pharmacy segment as the company is receiving lower payments from insurers for drugs sold in U.S.-based pharmacies. Reimbursement rates from generic drugs have been historically high, enabling Walgreens to benefit from the spread between the cost of the drugs and the price charged to insurers. This has been changing, though, as insurers have been putting increased costs on pharmacy chains -- increasing reimbursement pressure and lowering revenue for Walgreens.

Political changes have increased pressure on drug prices, as well. The Trump administration has made a priority of reducing the red tape in drug pricing, increasing generic offerings, and eliminating the rebate policy that allowed drug companies and benefit managers to charge higher prices on drugs. In addition, Democrats have added proposals that will allow the government to negotiate drug prices for all Medicare-related prescriptions.

Increased pressure on the U.S. healthcare system is directly impacting Walgreens and will continue to do so under the current administration. The fall in generic drug prices has slowed, however, the lower prices on branded drugs in addition to the government oversight on insurers will continue to plague pharmacies' profitability in the coming months -- hampering growth and increasing risk for shareholders.

Increasing the buying age of tobacco

In September 2019, Walgreens announced that the company will require customers to be 21 years old to purchase tobacco products. This decision was based on the Food and Drug Administration's (FDA) increased oversight on Walgreens and other retailers who sell tobacco products to adults under age 18.

Walgreens was one of the heaviest violators among the several the FDA investigated. According to the FDA, 22% of the Walgreens locations that were inspected were found to be illegally selling products to minors.

Pressure from the FDA and Congress forced Walgreens to increase the selling age of tobacco to 21. Walgreens enacted a "Card All" policy in 2019. This decision has put a damper on tobacco sales, decreasing retail sales during the recent quarter by 2.2% year over year, attributing a 0.5% decrease in comparable sales from the "continued de-emphasis of tobacco."

A decent dividend with a shaky future

Given the increased competition and rising political influence within the healthcare industry, Walgreens' growth is stalled in the near term. Walgreens management during the recent quarter pointed to a $1.8 billion cost savings by 2022 from a combination of store closures, inventory optimization, and the adoption of information technology within business operations, however, these are the only levers Walgreens management has to pull at the moment.

Overall, Walgreens' forward dividend yield of 3.38% is a saving grace for income investors in combination with a 31.23% payout ratio, leaving plenty of room to continue the 6.58% five-year dividend compound annual growth rate (CAGR). As revenue continues to flatline, investors will be looking at the costs of doing business, paying close attention to the $1.8 billion cost-cutting initiative and the gross profit margin -- which is at 21.61% per the recent quarter.

Purchasing shares of Walgreens at the current valuation isn't outlandish as Walgreens' forward price to earnings of 9.25 leaves shares at a discount in comparison to CVS' 10.25. But investors need to be careful as increased political pressure on the healthcare industry may provide enough systemic risk to impact the financial performance of the entire industry -- leaving shareholders a nice dividend but a substandard stock price performance for 2020.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Justin Cardwell owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends CVS Health. The Motley Fool has a disclosure policy.


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