Walgreens: Another Dividend Cut Could Be Coming Soon (NASDAQ:WBA) (2024)

Introduction

Walgreens (NASDAQ:WBA) was once a stock I held in my portfolio, excited about the company's turnaround story they started a few years ago. But since then, it hasn't turned out to be great for the company as they have faced headwinds, forcing them to cut the dividend earlier this year.

Moreover, during their recent earnings, WBA's cash flows have continued to face downward pressures. Putting into question their ability to pay future dividends, as free cash flow does not cover the current dividend of $0.25. In this article, I discuss the company's recent earnings, cash flows, and dividend coverage to see if another dividend cut could be in the works for the healthcare giant soon.

Previous Hold Rating

I last covered Walgreens in an article titled: Walgreens Q1: Dividend Cut Now What? This was after the company had just slashed its dividend by nearly 50%, losing its dividend streak of nearly 50 years. I upgraded the stock from a sell in my prior article as the dividend cut was expected to free up capital, further helping their transition into a full-blown healthcare company.

But since then, headwinds have persisted and the share price declined even further, dropping more than 36% from nearly $25 to less than $15 a share, where it trades at the time of writing.

I discussed the company's financials where free cash flow was expected to grow 54% over the next two years while cash from operations was expected to grow to $4.74 billion over the same period. I also touched on their balance sheet, which saw Moody's downgrade the company to non-investment grade.

Latest Earnings

Walgreens reported their Q2 earnings back at the end of March with a beat on their top and bottom lines thanks to their cost-cutting initiatives. During Q2, management stated they expected this to be in the range of $600 million and $500 million for working capital.

Although they managed to beat on EPS by a respectable amount with this coming in at $1.20, they were still forced to narrow their full-year EPS guidance to $3.20 - $3.35, down from $3.20 - $3.50. This is likely one reason for the further share price decline, as the market tends to react negatively to narrowed guidance. We saw this earlier this month with coffee behemoth Starbucks (SBUX) who experienced a sell-off when management narrowed their full-year guidance.

This showed the company is still facing headwinds and that the turnaround could be much more difficult, even after cutting their dividend by nearly 50%, and freeing up capital. However, they did show some positive signs during the quarter.

They delivered their first ever positive quarter of adjusted EBITDA as a result of Shields' strong performance. VillageMD also continues to expand their clinic footprint and prioritize costs, which should lead to profitability. Full risk lives grew double-digits by 19% during the quarter.

Furthermore, sales also were up 5.7% on a constant currency basis. This is in comparison to Q1'23 that saw sales growth of 4.5%. U.S. and international retail pharmacy sales grew 4.7% and 3.2%, respectively. U.S. pharmacy comparable sales also were up 8.7%, driven by volume growth.

But while they did see growth in those areas, U.S. retail comparable sales declined 4.3% as consumers continue to face financial pressures from high-interest rates. Management attributed this to weaker sales during the holiday season, as well as a weaker respiratory season. Additionally, as interest rates have remained steady for quite some time, consumers continue to feel the impact of inflationary pressures.

Management touched on this during the earnings call:

Within retail, our U.S customers confronting considerable pressure from multi-year inflationary trends and depleted household savings with US household debt at record levels and delinquency rates on the rise. Our shopper is making deliberate choices to seek value resulting in channel shifting behavior. We're responding to these market dynamics by making investments in key value items and focusing on our capabilities to engage with customers in an intelligent, targeted way.

From the prior year same quarter, EPS did increase from $1.16 as comparable sales in the U.S. retail pharmacy segment grew from 3.1% on an annualized basis. And management continues to look for ways to boost profitability and growth moving forward.

Dividend Coverage & Balance Sheet

Although the dividend was already cut, WBA still pays a respectable dividend of $0.25. And at the current price of less than $16, this gives them a yield of 9.3%. This is significantly higher than peer CVS Health's (CVS) 4.9% yield at the time of writing.

And while WBA's higher yield is currently attractive and trading above treasury yields, their dividend safety should be of concern. During the first half of the year, WBA's operating cash flow and free cash flow were both negative, which is something you never want to see from a dividend-paying company. Especially one with a long operating history like Walgreens.

Tight coverage during tough economic times is expected, but negative cash flows are a huge red flag. Especially after the company already cut the dividend just 4 months ago. Using their shares outstanding of 864.6 million, WBA's dividend would require free cash flow of $216.15 million to cover this. Something their current free cash flow cannot do. I also suspect if this continues, another dividend cut could happen by the end of the year.

And as seen by the chart above, the dividend currently is not covered. The good thing is the company did have cash on its balance sheet of $668 million. But as an investor, seeing one of your holdings use cash on its balance sheet to fund the dividend is never a good sign.

Walgreens also recently sold shares in its Cencora (COR) stake for proceeds of $400 million. This may have been used to fund the dividend. But as mentioned previously, investors should consider companies not covering their dividends by free cash flow to be risky investments, despite their upside potential. In my opinion, I think it would be best for management to eliminate or suspend the dividend, similar to Disney (DIS) during the pandemic.

This would be free up nearly $1 billion in capital, and if they can successfully manage to become cash flow positive, continue to focus on their transition and buyback shares in the foreseeable future.

Management does expect this to get better during the second half of the year, however. Whether this will happen or be enough to cover the dividend remains to be seen. To be fair, the company was impacted by more than $1 billion as they had roughly $700 million in legal payments and nearly $400 million in Boots Pension Plan Annuity contributions.

Moreover, if WBA can become cash flow positive by the end of their fiscal year, I would consider upgrading the stock as this shows the current dividend is likely safe for the foreseeable future.

Furthermore, the company had nearly $2 billion in short-term debt due and $7.5 billion in long-term debt, which they have been paying down over the past year. This decreased from roughly $8.1 billion a year ago. But while they can continue to sell shares of their Cencora stake to pay this down, their dividend payments will continue to be speculative going forward.

Pricing In Dividend Cut?

With a forward P/E of just 4.46x, WBA may be a great investment for those willing to take risks. Especially since it trades well below the sector median's 17.72x, and almost half of their own 5-year average of 8.17x. As previously mentioned, their dividend yield is also attractive, but how long can the company continue paying its dividend is the question.

Peer CVS recently sold off as well, but still has a forward P/E of 9.6x, making them attractive as well. But unlike the former, CVS' current dividend is well-covered with cash flows. I touched on this in a recent article you can read here.

Furthermore, they also trade below their book value of $15.63 giving them a P/B ratio of roughly .94x. In my opinion, I think the market may be pricing in another dividend cut. In the short to medium term, I think the upside is limited but if they can continue their cost-savings efforts and become cash flow positive, then they can see some upside in the foreseeable future.

Upside Potential

Using their dividend estimates, over the next 5 years, WBA is expected to have an average earnings growth rate of 2.2%. Using the DCF method and a WACC of 9%, this gives investors significant upside to their price target of roughly $48 a share. I use a lower growth rate of 2% the next 5 years to manage expectations and account for headwinds along the way, of which WBA is no stranger to as a result of their business model. Moreover, if the company can avoid cutting their dividend and sustain positive cash flow while successfully transitioning over the next few years, then WBA could potentially reward patient investors.

Further Downside Risks

I think the biggest risks here are downside potential from an additional dividend cut and future lawsuits for the company going forward, impacting their cash flows. As previously mentioned, their cash from operations was impacted from legal payments. And if they face any additional lawsuits in the future, management may be forced to cut the dividend, or eliminate it altogether while they focus on becoming cash flow positive. An additional risk worth mentioning that affects Walgreens long-term is their failure to quickly and efficiently transition into the healthcare segment like CVS Health Corporation and Amazon (AMZN).

Bottom Line

Walgreens at the current price offers investors an attractive yield nearing double-digits, which may be attractive for the short term. But for those with a long-term outlook, their transition may prove to be more difficult as the company plays catch up to peers like CVS and Amazon. Additionally, they continue to face headwinds from lawsuits and negative cash flows, further impacting their dividend coverage. This may ultimately lead to another dividend cut, which the market may be pricing in as the company is at its lowest level since 1998.

Management expects cash flows to increase during the second half of the year as they continue to focus on cost-cutting initiatives and prioritizing capital expenditures. This remains to be seen as consumers face tighter financial conditions as a result of higher interest rates. If Walgreens can manage to become cash flow positive by the end of their fiscal year, this could result in some strong upside and an upgrade to hold. But as a result of their negative cash flows and a dividend cut looking all but imminent, I am downgrading Walgreens to a sell.

The Dividend Collectuh