Walgreens: Think Absolutes, Think Long-Term

Drug-store giant Walgreens Boots Alliance  (WBA) got hammered April 2 after reporting disappointing fiscal second-quarter earnings.

Management also reduced guidance for full FY 2019 (ends Aug. 31, 2019) from $6.55 per share to about $6.00.

WBA was not expensive going into the news, yet the shares plunged anyway. Talking heads on CNBC and elsewhere were keen to explain why the stock was down over 12% on the day.

I didn't hear one person recommend buying, despite the fact that the bad news had already been (more?) than reflected.

WBA has been a good operator. From FY 2010 through FY 2018, earnings per share and dividends each rose by more than 174%. The stock followed suit, peaking north of $86 during each of the years 2015 through 2018.

This week's selloff left WBA up much less than would be expected based on all its fundamental growth. As of April 2, WBA's nine-year total return was 64.4%, compared with EPS improvement of almost 179%.

That was due to P/E compression which should lead to outsized future returns.

WBA is financially strong, pays a well-covered and generous dividend, and scores high in terms of earnings predictability.

Typically, investors need to "pay up" for traits like that.

Walgreen's average multiple over the most recent eight years has been 16.5x. A normal yield was about 2.18%.

At $55.26, it fetched just 9.2x the now reduced estimate for the FY ending Aug. 31, while yielding 3.18%.

Assuming a lower-than-historical P/E due to present-day lack of enthusiasm and you still come up with a real-time fair value of around $84. That suggests upside of at least 52% -- plus dividends.

Interruptions of growth are almost always panned by Wall Street. Buying into stocks like that, though, usually ends up being well rewarded. WBA fell from $47.10 in 2011 to $28.50 in 2012, when EPS dipped by 4.2%.

Contrarian types, who bought, rather than bailed, rode Walgreens to almost a quadruple at 2015's peak. Traders buying today, at one of WBA's best valuations ever, should see similar results.

Owning WBA outright appears the best way to capture maximum profit from the $55-$56 range. Option sellers can nibble at the edges by writing some Jan. 15, 2021 puts, using in-the-money strikes such as $62.50 and $65.

Break-even prices on those dropped to $50-to-$51, lower than WBA's absolute lows since 2013.

Pocketing $1,230 or $1,400 per 100-share commitment, while knowing your worst case, would be that favorable makes a lot a sense.

WBA is not only near the low end of its five-year range, its EPS more than doubled while the stock price made a round trip toward its 2015 nadir. Dividends are up 37.5% since the end of 2014 as well.

Instead of fretting about one lukewarm quarter, smart investors should be focused on WBA's absolute value and upside potential.

You only get so many chances to buy high-quality stocks at bargain basement prices.

Long WBA shares, short WBA Jan. 2021 put options.