Barron's, December 10, 2014 research by Mizuho: 'A Red Light for Walgreen | The drugstore chain’s shares get downgraded due to significant integration risk and increased management turnover, among other issues"

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Source: Barron's, December 10, 2014 research

Hot Research

A Red Light for Walgreen

The drugstore chain’s shares get downgraded due to significant integration risk and increased management turnover, among other issues.

Dec. 10, 2014 6:29 a.m. ET

Walgreen ( WAG: NYSE)
By Mizuho ($67.90, Dec. 10, 2014)

We are downgrading Walgreen to Neutral from Buy and cutting our price target to $72 from $83.

We see limited meaningful upside to our fiscal 2015-2017 adjusted earnings-per-share estimates. Walgreen (ticker: WAG) released an updated proxy on Nov. 24 providing, for the first time, longer-term (fiscal 2015-2018) pro forma adjusted EPS, earnings before interest, taxes, depreciation and amortization (Ebitda) and revenue estimates for the completion of Step 2 of the Alliance Boots transaction. We think the longer-term goals in the proxy will be difficult to achieve due to significant integration risk, increased international exposure and limited near-term potential for improvement in base operating trends given the increased management turnover.

Post the completion of Step 2, we estimate Alliance Boots will account for roughly 30%-35% of revenue and 27%-30% of Ebitda. The added international exposure increases the risk profile for Walgreen given growth and currency headwinds. Our stand-alone Alliance Boots estimates assume mid-single digits Ebitda growth helped by continued mergers and acquisitions (M&A). We think currency exposure could be a source of near-term downside risk to fiscal 2016 adjusted EPS outlook of $4.25-$4.60 and look for guidance on this issue when Walgreen reports its fiscal first quarter on Dec. 23.

Our fiscal 2015-2016 adjusted EPS already assumes the deployment of the majority of free cash flow, so any upside would come from additional leverage. We estimate that the combined company will generate more than $4 billion in free cash flow annually, but our estimates already assume much of that deployment via share repurchases, limited debt repayment and dividends over the next three years. Any M&A would likely be Alliance Boots expanding its international footprint.

Walgreen is trading at 15.2 times and 15.6 times our pro forma calendar and fiscal 2016 adjusted EPS versus its ten-year forward price-to-earnings (P/E) averages of 16.4 times and CVS Health’s ( CVS ) current 2016 P/E of 15.8 times. Our new price target is based on a P/E of 16.4 times applied to our fiscal 2016 adjusted EPS of $4.39. On a cash flow basis, our price target assumes a 5% free-cash-flow yield on fiscal 2016 free cash flow.

-- Ann Hynes
-- Tim McDonough

The companies mentioned in Hot Research are subjects of research reports issued recently by investment firms. Their opinions in no way represent those of Barrons.com or Dow Jones & Company, Inc. Share prices at the time the report was issued and the date of the report are in parentheses.

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