Walgreens Boots Alliance (US:WBA) was among the first wave of companies kicking off US earnings season, laying bare the impact of a full three months of the Covid-19 pandemic. But if its third-quarter results are any indicator of what is to come, investors on both sides of the Atlantic might find themselves recalibrating their expectations.
The global retail and pharmacy group kept revenue flat at $34.6bn (£27.7bn) in the three months to 31 May, but the pandemic crushed profitability – it swung to a $1.7bn net loss, compared to a $1bn net profit a year earlier. This came as it booked a $2bn non-cash impairment on its UK business – which comprises Boots UK and Boots Opticians – reflecting deteriorating business conditions and the expectation they will remain “very depressed” throughout the summer.
The overall gross margin was squeezed by a shift in the retail sales mix from higher margin discretionary products to lower margin essential goods. Meanwhile, operating costs rose by a third to over $8bn as Walgreens implemented social distancing and hygiene protocols. The group is now aiming to make annual savings of more than $2bn by the end of 2022, up from its previous $1.8bn target.
Of some comfort to shareholders is that the quarterly dividend was increased by 2.2 per cent – marking 45 consecutive years of growth – although buybacks have been suspended. But that should be placed in the context of a stock that has lost almost 60 per cent of its value over the past five years.
Retail on the ropes
Covid-19 triggered an estimated $700m-750m hit to Walgreens’ sales, largely originating in locations outside of the US. The UK was particularly impacted by stay-at-home measures, with footfall in Boots UK stores plunging by 85 per cent in April. It’s a worrying sign for investors looking at other retailers – despite Boots being deemed an ‘essential business’ and keeping most of its stores open during the lockdown, like-for-like sales almost halved. It also lost market share as consumers chose to purchase items alongside their grocery shop rather than making a separate trip to its stores.
As it attempts to nurse itself back to health, Walgreens is joining an ever-growing list of companies announcing staff cuts and store closures in the UK. Plans to eliminate more than 4,000 jobs and shutter nearly 50 opticians come on top of the 200 Boots UK stores it said it would be axing last year. But it will still be left with more than 2,000 Boots UK sites on the hook for business rates, rent and staff costs at a time when people remain reluctant to head down to the high street in person. The latest data from retail analytics provider Springboard indicates footfall across UK high streets was still down more than 50 per cent year-on-year in June.
That’s without mentioning the significant pressures Boots was facing before the pandemic, including the threat of online retailers to its considerable bricks-and-mortar estate. Price competition from supermarkets and discounters will only mount as they encroach further on the health, beauty and toiletries space.
It’s not all bad news. Chief financial officer James Kehoe said that Boots’ online traffic “reached Black Friday levels on a daily basis”, with online sales soaring by almost four-fifths across the quarter. But the fulfilment costs associated with home deliveries rather than its preferred click-and-collect orders chipped away at margins.
Intuitively, with its focus on health and personal care products, you might think Boots would show more resilience during this crisis. Brokers were certainly caught off guard by its underperformance – even excluding the $2bn impairment, Walgreen’s adjusted EPS of $0.83 came in 30 per cent below analysts’ expectations. Having downgraded their full-year estimates, analysts may well now turn to other retailers and tweak their numbers accordingly.
Pharmacy challenges
Retail is not the only part of the group under pressure. Walgreens’ pharmacy operations have also been knocked by Covid-19, amid a decline in prescription volumes. For Boots UK, that decline prompted a 1 per cent drop-off in like-for-like pharmacy sales. In the US, a 1.3 per cent hit to prescription volumes kept growth in check at 3.5 per cent.
Those prescription trends have seen “steady improvement” since the end of May. But they still point to a reduction in routine GP and hospital appointments during the pandemic – an issue that has given rise to broad repercussions for companies across the medical spectrum. Stateside healthcare giant Merck (US:MRK) is a case in point; roughly two-thirds of its pharmaceutical sales comprise doctor-administered products, and – despite strong demand – these have been hit by distancing measures and delays in elective procedures.
Slowdown in routine healthcare
Merck’s upcoming Q2s should shed further light on the effects of the pandemic – although, arguably, its blockbuster ‘Keytruda’ drug and vaccine portfolio will continue to drive diversified sales growth in the longer-run. But even so, questions remain about how quickly Walgreens and the wider healthcare industry can move forward from this hiatus in routine care; particularly given that the discovery of a successful vaccine or treatment for Covid-19 is unlikely to reap significant financial rewards for the developer. Time is of the essence; a new report from the British Medical Association says that the NHS faces a “huge backlog of unmet patient need”. It warns that millions will have missed opportunities to receive diagnoses during the crisis.
Ongoing pressures
As with its retail offering, Walgreens’ pharmacies were already dealing with challenges before the virus struck. For one thing, almost all of the group’s American pharmacy sales constitute reimbursements from government agencies and insurance firms – meaning it is vulnerable to any decision by those third-party payers to change their terms. Indeed, in Q3, less than half of the US pharmacy division’s 9.6 per cent gross-profit decline was linked to the pandemic. Most of the erosion stemmed from “ongoing reimbursement pressure”.
The pharmacies also face intensifying competition from the virtual realm – not least an online service provided by tech giant Amazon (US:AMZN), via its acquired business PillPack. While digital healthcare had been picking up pace pre-pandemic, restrictions on movement have only made it more relevant.
The group has, in fairness, taken steps to innovate. It recently unveiled a strategic partnership with Microsoft (US:MSFT) and Adobe (US:ADBE), and is also tying together the doctor/pharmacy experience – working with VillageMD to open 500-700 doctors’ offices at its US pharmacy sites over the next five years. Looking ahead, it seems feasible that the group could extend this integrated approach to a full range of primary-health services. It’s a big bet; the plans will see Walgreens invest $1bn in equity and convertible debt over the next three years.
