Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche

Market Insanity

Can Walgreens Survive Brexit?

It has not been a very good year for Walgreens Boots Alliance (NASDAQ: WBA). First the Federal Trade Commission or FTC cannot make up its mind about the company’s acquisition of Rite Aid (NYSE: RAD), and now Brexit threatens its second largest market.

The company’s exposure to Brexit is huge because its Boots UK subsidiary is the United Kingdom’s largest pharmacy operator; with over 2,500 locations. There are several ways Brexit could decimate that business.

The most obvious would be a prolonged economic downturn; particularly one that reduced tax revenues for the United Kingdom’s National Health Service, or NHS. Almost all prescriptions in the UK are paid for by the NHS, which depends on taxes for revenue.

The Unraveling of the United Kingdom

An even worse scenario would be the unraveling of the United Kingdom. Scotland’s head of government; First Minister Nicola Sturgeon, is demanding a referendum for her country’s independence. Sturgeon’s position is that Brexit effectively dissolves the UK, because 62% of Scotts voted against it.

Possible outcomes of Scottish independence include the collapse of the pound, and the erecting of customs barriers between Scotland and England. A major dilemma for Boots would be the National Health’s future. Would an independent Scotland keep the present system of government-run free clinics and hospitals, or switch to a health insurance system in which the government would reimburse providers?


Further complications are raised by Northern Ireland, where 55.7% of voters also opposed Brexit. Would Northern Ireland become independent, join the Irish Republic or enter into some sort of federation with Scotland?

In such an environment it is impossible for a company to plan for the future. The Brexit mess is further complicated by demands for London’s independence, no I’m not kidding, even the city’s mayor is talking about it; and the possibility of a Brexit repeal. There is an organized movement to overturn Brexit, and I doubt it will go away.

My take is that the British will muddle through Brexit like they always do, but Boots may find itself facing a different business environment. The problem is nobody knows what that environment will be.

Will the Rite Aid Walgreens deal Go Through?

Brexit is not the only uncertainty at Walgreen Boots Alliance, nobody knows if the FTC will approve its Rite Aid acquisition. The deal was announced in November, and there is no sign that the commission has made any sort of decision on it.

The latest story from CEO Stefano Pessina is that the deal will go through by the end of 2016. During the last earnings call, Pessina said his lawyers had not heard any negative signals from the FTC. That means neither he nor his attorneys have heard anything.


Instead Pessina thinks the deal will go through in November or December; a full year after it was announced, one has to wonder why is it taking so long to conclude? Are the same FTC bureaucrats that killed the Office Depot (NASDAQ: ODP) and Staples (NASDAQ: SPLS) merger, going to block the Walgreens-Rite Aid deal?

The collapse of that merger would devastate Rite Aid and hurt Walgreens. Although Walgreens itself does not need Rite Aid, CNBC reported that its US pharmacy sales rose by six percent during the first quarter. The increase was based largely on increases in the number of prescriptions covered by Medicare’s Part D benefit.

Walgreens Retail Sales are flat

Not getting Rite Aid would also free Walgreens to embark on a major expansion in the US. One possibility would be adding to its retail offerings, because retail sales are flat. The company’s executive team admitted that US retail sales grew by just .1%. Possible products it could add are a greater selection of private label foods, fresh produce, organic food, office supplies or ready to eat meals.

Beyond that the company might look into other sources of revenue such as fuel sales, jewelry, financial services, clothing or joint ventures with banks, fast-food outlets or even online retailers like Amazon (NASDAQ: AMZN). Such diversification might be necessary, because Walgreens faces a growing number of competitors offering those amenities and pharmacies.


Walgreens is facing intense competition in US retail from companies like Walmart (NYSE: WMT), Costco Wholesale (NASDAQ: COST), Kroger (NYSE: KR) and Safeway; all of which operate pharmacies in their stores. A more direct threat is CVS Health (NYSE: CVS) which recently took over Target’s pharmacy business. Growing threats to its retail operations include dollar store operators like Dollar General (NYSE: DG) and the discount grocery chain Aldi.

All of this means the collapse of the Rite Aid deal would be an opportunity for Walgreen. It would be able to reinvest the $9 billion it would have used to buy the smaller druggist, and not have to close several hundred stores. Most analysts expect the FTC to approve the acquisition with the condition that Walgreen sell off or close hundreds of stores.

Can Rite Aid Survive without Walgreen?

The most interesting twist in this saga is that it appears Walgreen Boots Alliance can survive without Rite Aid, but Rite Aid might perish without Walgreen. The May 31 numbers show that Walgreen is making money but Rite Aid is not.

Walgreen reported very healthy revenue growth for the last quarter. Revenues rose by $710 million, rising from $116.53 billion in February to $117.24 billion in May. That gives Walgreen more revenue than Amazon which reported $113.42 billion on March 31. Rite Aid’s revenue growth for the quarter was even more impressive rising from $30.74 billion in February to $32.27 billion in May – an increase of $1.53 billion in three months.


The problem is that Rite Aid is not making any money off that revenue. On May 31, ycharts data indicates that the drugstore operator reported a profit margin of .6%, a diluted earnings per share or EPS figure of .1356, a net income of $142.04 million and a free cash flow of just $37.49 million.

Some of Rite Aid’s other numbers indicate a chain that is very close to the death spiral. The company had just $144.84 million in cash and short term-investments. Yet it had $10.66 billion in liabilities and $6.92 billion in long term debt.

Walgreen is Making Money

Walgreen Boots is still making quite a bit of money from its revenue. On May 31, the drugstore giant reported a diluted EPS of 2.83, a net income of $3.169 billion, a profit margin of 3.74% and free cash flow of $1.857 billion.

Walgreens also had quite a bit of float it reported $3.291 billion in cash and short term-investments and $6.694 billion in cash from operations on May 31. It also had $67.33 billion in assets, $13.52 billion in long-term debt and $34.45 billion in liabilities. That means Walgreens certainly has the resources to survive Brexit.


More importantly the numbers justify the $82.10 a share Walgreen was trading at on July 13, 2016. Investors will not be disappointed with the 1.75% dividend yield and 10.32% return on equity from Walgreen Boots Alliance.

What will happen to Rite Aid?

A lot of investors will be wondering what happens to Rite Aid if the Boots deal falls through? Somebody else will buy it because Rite Aid is a bargain it’s a company with a market cap of $7.212 billion; and an enterprise value of $13.99 billion, that generated $32.27 billion in revenue and $789.51 million in cash from operations.

If the FTC kills the Walgreens deal, somebody else will definitely buy Rite Aid. Possible buyers include Cerberus Capital Management owner of Safeway and Albertsons, Dollar General (NYSE: DG), Kroger, Walmart and Berkshire Hathaway (NYSE: BRK.B). Another intriguing possibility is Aldi South, which operates the US Aldi stores.

Rite Aid will survive but it is still a lousy stock investors should stay away from. Walgreen is a great stock with or without Rite Aid that will prosper in spite of Brexit.