Is Walgreens Feeling the Amazon Effect?

Walgreens Boots Alliance (NASDAQ: WBA) appears to be the latest retailer to experience the “Amazon Effect.” The drugstore giant just reported its second straight quarter of declining revenues.

Back in August 2016, WBA’s revenues hit an all-time high of $117.35 billion. Those revenues fell to $116.82 billion in November 2016, and $116.08 billion in February 2017. The revenue Walgreens reported on February 28, 2017, was actually lower than the number it reported a year earlier; $116.53 billion.

The cause of the revenue drop is obvious, Walgreens admitted that same store sales fell by 2.4% during the second quarter which ended in February, in a press release. Retail sales fell by 2.7% between second quarter 2016 and second quarter 2017.

How Amazon is Hurting Walgreens

The biggest declines were in the consumables, general merchandise and personal care departments, the report states. That points straight to Amazon (NASDAQ: AMZN) which competes directly with Walgreens in some of those areas.

Amazon has been aggressively increasing its sales of cleaning supplies, laundry detergent and other items that can be described as “general merchandise” even launching its own line of Household Essentials. The Everything Store is also increasing its sales of personal care items such as razors and deodorants.

The strategy is apparently working Amazon added $28.98 billion in new revenues in 2016. It also overtook Walgreens in revenue volume for the first time, at the beginning of 2016; Walgreen’s revenues of $112.92 billion easily exceeded Amazon’s of $107.01 billion. Now Amazon’s revenues surpass Walgreen’s by nearly $20 billion.

Changing Shopping Habits Threaten Walgreens

The biggest problem Amazon creates for chains like Walgreens is getting people out of the habit of shopping. Instead of running out to fill a shopping list more and more people shop from home, or simply use Amazon Dash to order at the push of a button.

Another way this harms Walgreen is to force the drugstore to offer steep discounts to counter Amazon’s convenience. That only works partially because not every shopper is price conscious; many will value the time and effort saved by not going to the store as more valuable than the money they save.

It also creates the problem of decreased profits from the discounted items. The prices and profit are lower but Walgreens’ operating expenses are still the same. There’s also the limit to discounting, at some point Walgreen will lose money on the sales. The company will no longer make money on those items, which raises the prospect it will have to stop selling general merchandise.

Is Walgreen’s Making Money?

The Amazon danger may not be as great as some critics think because the company’s core business is pharmacies. Sales of prescription drugs are one business Amazon cannot compete in and they are growing.

Sales from the pharmacy accounted for 66.5% of the revenue from Walgreens US stores, during the second quarter. The sales at the company’s U.S. pharmacies grew by around 1.5% between 2016 and 2017.

Those gains were offset by the company’s Retail Pharmacy International division where second quarter sales fell by 14.5%. The major cause of that was currency conversion but overall international sales did fall by 1.9% on a constant currency basis.

Despite that Walgreens was doing well in the income department. The net income rose from $3.368 billion in February 2016 to $4.247 billion a year later. The free cash flow grew from $2.036 billion to $2.596 billion during the same period. Cash from operations rose from $6.412 billion to $8.144 billion.

Walgreens is making a lot of money, and accumulating quite a bit of float. It reported $11.82 billion in cash and short-term investments and $72.5 billion in assets by the end of second quarter. Cash and short-term investments rose $3.586 billion to $11.82 billion over the course of 2016.

Walgreens is a Value Investment

All this makes Walgreens a value investment because it can accumulate a lot of cash with declining sales. The numbers prove Walgreens can probably survive without the general merchandise sales and fend off competition from Amazon.

One big advantage Walgreens has here, is that it possesses the resources to restructure its stores to deal with new retail realities. For example Walgreens can stop selling general merchandise and instead offer a pickup location for items ordered online. It can also offer shipping services like the ones it gained in its recent FedEx (NYSE: FDX).

Another revenue stream Walgreens has is tobacco sales which its competitor CVS Health (NYSE: CVS) phased out and Amazon will probably avoid. There are also some new businesses including sales of hot food and ready cooked meals and same-day deliver services via Uber.

Therefore Walgreens will survive and make money with or without the Rite Aid (NYSE: RAD) acquisition. Despite that its stock may not be that great an investment.

My take is that the recent sales declines make Walgreens shares overpriced at the $85.93 price they achieved on April 27, 2017. The share price may fall soon, and offset the 14.19% return on equity stockholders enjoyed on February 28.

If you’re interested in Walgreens Boots Alliance stock wait for the whole question of the Rite Aid merger to be settled before buying. Even with the 37.5¢ dividend scheduled for May 16 there are simply too many questions about this company’s future right now for it to be a true value investment.