Can Walgreens Survive the Retail Apocalypse?

Walgreens Boots Alliance (NASDAQ: WBA) has emerged as an unlikely victim of the retail apocalypse. Despite a semi-successful acquisition of Rite Aid (NYSE: RAD) last year, Walgreens is plagued by falling stock prices and declining income.

Back on April 28, 2017, WBA stock hit a high of $89.69, that share price fell to $62.82 on October 27, 2017. By January 17, 2018, Walgreens share price had recovered $75.78. That was a dismal performance compared with Walmart’s (NYSE: WMT) share price of $102.70 and Costco Wholesale’s (NASDAQ: COST) stock price of $192.29 on 17 January 2018.

Walgreens is also making less money; the company reported a net income of $821 million on November 30, 2017. That was down from $930 million in November 2016, but an improvement over $802 million on August 31, 2018. Earnings before taxes were also down at Walgreens. WBA reported $1.048 billion in earnings before on 30 November 2017, down from $1.274 billion a year earlier.

Most bothersome was Walgreens’ operating cash flow of $961 million reported on 30 November 2017. It was down from $2.014 billion on August 31, 2017, but an improvement over $525 million a year earlier. Walgreens also reported a free cash flow of $583 million on 30 November 2017, down from $1.575 billion in August but up from $147 million in November 2016.

 Why Isn’t Walgreens Making More Money?

It is not supposed to be this way at Walgreens because gross profit, revenues, and operating income are growing at the company.

Walgreens reported a gross profit of $7.341 billion on 11 November 2017, up from $7.116 billion a year earlier. Operating expenses were $1.434 billion in 1st Quarter 2017, a slight improvement over $1.430 billion a year earlier.

Revenues grew by 7.86% during the 1st quarter of 2018. Walgreens reported revenues of $30.740 billion for 1st Quarter and $30.149 billion for 3rd Quarter. More importantly, operating expenses fell from $6.226 billion in August 2017 to $5.907 billion in November 2017.

Walgreens Retail Sales are shrinking

The logical inference from all this is that Walgreens’ expenses are simply eating up almost all of its revenue.

Business is certainly good at the largest US drugstore operator, Walgreen pharmacy sales increased by 14.1% during the 1st quarter, Drug Store News reported. Walgreens also filled one billion prescriptions in a 30 day period for the first time, during the quarter.

The increased prescriptions might not be leading to more cash because most of them are paid for by insurance. That can limit payments, and create problems because insurance payment can take some time.

A major dilemma is that other retail sales at Walgreens fell by 2.8% during the 3rd quarter, its earnings call revealed. That’s problematic because Walgreens uses the earnings from retail sales to offset expenses in pharmacy. Retail sales are vital to Walgreens because it can collect payment from them almost immediately.

My guess is that Amazon (NASDAQ: AMZN) and Walmart (NYSE: WMT) are slowly eating Walgreens’ retail business with aggressive online discounting of items like cosmetics and razors. Cosmetics alone make up around 9% of retail sales at Walgreen and they are an ideal product for e-commerce sales. Startups like Dollar Shave Club might also be having an impact.

A growing problem is the loss of pharmacy business to pushy brick and mortar competitors like Kroger (NYSE: KR), Walmart, and Costco. Total retail sales at Walgreen fell by .9% in the third quarter.

Walgreens Losses will increase

My prediction is that Walgreens’ losses will increase because it is absorbing over 1,000 Rite Aid locations.

The expenses of taking over all those stores will cut into the company’s profits. Converting Rite Aids to Walgreens is expected to cost $500 million. Integrating the Rite Aids into Walgreens’ ecosystem might cost as much as $750, the company’s earnings call revealed.

A related expense will be absorbing 40% of Sinopharm Holding Guoda Drugstores, a leading pharmacy in the People’s Republic of China. That seems like a lousy deal to make right after buying Rite Aid for $4.375 billion.

Walgreens Needs More Revenue Fast

Walgreens is going to have to find some new sources of revenue or drastically cut expenses fast.

An obvious solution would be to shrink Walgreens stores by cutting back on sales of things like cosmetics or razors or getting rid of them entirely. A clever move would be to eliminate products like laundry detergent or groceries from Walgreens. Simply eliminating household supplies would be a huge saving.

An even better solution would be to create pharmacy-only stores, with no general retail. That would allow for drastic cuts in expenses and allow Walgreens to concentrate on its. Since pharmacies account for 72.4% of Walgreens’ sales, this would enable concentration on the main profit center.

Another option is to combine a Walgreens pharmacy with another business operating under another brand. A logical combination would be a Walgreens pharmacy and a clinic, another would be Walgreens combined with an urgent-care facility.

Walgreens Needs to Team Up

Other potential combinations include Walgreens/Starbucks (NYSE: SBUX), Walgreens/Aldi, Walgreens/Lidl, Walgreens/FedEx Office, Walgreens/UPS Store, Walgreens/Seven11, Walgreens/Whole Foods 360, Walgreens/Kroger, Walgreens/Walmart Pickup, Walgreens United States Postal Service, Walgreens/Office Depot, and Walgreens/McDonald’s (NYSE: MCD).

An even better solution might Walgreens/Amazon, where customers can pick up a prescription and their Amazon order. Why not Walgreens/Nordstrom (NYSE: JWN) in affluent areas and Walgreens/Aldi or Walgreens/NAPA in working-class neighborhoods?

Walgreens/Aldi seems like a logical combination because it would enable the company to drop groceries and dry goods completely. Since Aldi, Lidl, and Amazon’s Whole Foods 360 plan big expansions and need locations it makes sense. There are also banks like Wells Fargo (NYSE: WFC) and JPMorgan Chase (NYSE: JPM) which are closing branches, why not a bank and a pharmacy together?

The biggest advantage to such combinations is that Walgreens would be able to generate additional revenue by renting out half or most of the store. Kohl’s (NYSE: KSS) is already experimenting with such a concept. Walgreens might turn a business that is a drag into a profit center.

One thing is certain new thinking at Walgreen and fast. Hopefully, the headlines about Walgreens planning to rethink retail are true. Like Walmart, this drugstore needs a drastic makeover just to survive.

Disclaimer: This commentary is intended as food for thought, not as financial or investment advice!! Please, folks, do your own research and thinking and make up your minds.