Following the quarter and after analyzing the new RAD deal, Leerink is incrementally more cautious on shares of Walgreens Boots Alliance Inc. (NASDAQ:WBA). In Leerink's view the quality of earnings in the quarter were low, WBA has been plagued by constant reimbursement pressure and competitive forces in the Retail Division, and while the new RAD deal is structured in a favorable manner, it is not convinced the FTC will allow the transaction to go through. Despite these headwinds Leerink believes sentiment is fairly negative on the stock already, and with $5B of share re-purchases underway it believes the stock is due for a near-term bounce especially if investors begin to get more positive on the new RAD transaction. The firm maintains its OP rating but it reduces its price target and 2018-19 estimates.
While WBA beat EPS consensus this past quarter by $0.03 and full-year guidance was increased by ~ $0.08, Leerink estimates $0.11 of the beat and raise was driven by a lower tax rate. While USA Retail volumes were very good, the problem is that these volumes are being won due to a lower price which is putting pressure on reimbursement and gross margin. At first glance, the SS Rx growth of +8.3% y/y and total Rx growth of +8.5% y/y seem very strong especially given the fact that WBA had its best "market share" quarter ever, coming in at 20.3%. However, USA Retail gross margin contracted 174 bps y/y and if the firm excludes the unfavorable impact of specialty, USA Retail gross margins still would have contracted 74bps y/y. Gross profit dollars in USA Retail declined on a y/y basis. While USA Retail adjusted operating margin of 6.5% held steady, the operating income growth was from SG&A cost reductions. Leerink is concerned that much of the SG&A cost reduction efforts from the AB merger will largely be complete by F2017- end. The firm is also becoming more cautious on "restructuring charges" that management is consistently reporting (it estimates ~$0.10/share in F3Q:17).
In the firm's view the new RAD deal is a positive because it keeps the deal alive, and it would add ~2,186 stores which could have taken years to acquire under another type of transaction. Leerink estimates that these ~2,186 stores generate ~$13B of revenue and ~ $390M of EBITDA which implies a price-tag of 13.3x EBITDA given that the deal is for $5.175B. This ~$390M of EBITDA assumes an EBITDA margin of 3% which may be low since the deal is for stores and not corporate overhead. However, RAD's Retail adjusted EBITDA margin has been trending in this ~3% range, so the firm views the deal price tag as being high.