Here are some portfolio changes from last week.
New Investment: Walgreens Boots Alliance (WBA)
We purchased stock in Walgreens last week. Concerns that Amazon is expanding into drug distribution with their purchase of Pillpack earlier this summer knocked the stock down to a pretty attractive valuation. I think this is a massive overreaction similar to what we’ve seen with other retailers over the last few years. Last summer we used similar concerns to buy Target (TGT) and to also buy more O’Reilly Auto Parts (ORLY) – both of which have bounced back to new highs this year. This is appears to me like a similar opportunity with Walgreens.
Pharmacies are very steady, recession resilient businesses. I largely think the concern about Amazon is overblown because the majority of people who buy prescription drugs are older (relatively speaking) and less open to changing the way they do things. Also, each state has its own regulations regarding drug distribution, storage and sales so I think it will be a long, uphill climb for Amazon to gain marketshare.
The US pharmaceutical industry is roughly $450 billion and growing every year. Pillpack’s sales in 2017 were estimated at just over $100 million. If the industry continues to expand at a low rate of growth, as is expected with aging Baby Boomers, that’s plenty of business for Amazon to pickup without stealing share from the incumbents.
Walgreens purchased just shy of 2000 stores from Rite Aid earlier this year which has helped increase their scale and purchasing power. With this, their expansion plans are pretty much behind them so I expect most of future cash flows to be returned to shareholders via dividends and buybacks. They’re also focusing on improving the efficiency of their stores by revamping the retail strategy, enhancing their digital experience, and expanding strategic in-store partnerships. All of these should aid in customer retention and increased prescription volumes.
One major concern for investors regarding the pharmaceutical industry right now is the issue of increasing drug prices. I think this is ultimately a negative for drug manufacturers but a positive for Walgreens. A pharmacy like Walgreens isn’t concerned about total revenue (cost of the drug) but total volume. We should see a continued push in the Pharma industry for more biosimilars and generics. Here’s some info from Walgreen’s latest 10-K illustrating why pressure on drug pricing should actually help them (emphasis added):
Generic prescription drugs have continued to help lower overall costs for customers and third party payers. We expect the utilization of generic pharmaceuticals to continue to increase. In general, in the United States, generic versions of drugs generate lower sales dollars per prescription, but higher gross profit dollars, as compared with patent-protected brand name drugs.
I really like how the stock has traded since the gap lower in July, suggesting it was a flush out and we should be clear to step in. We bought the stock around a 2.6% dividend yield and 9% Free Cash Flow yield on what I expect them to bring in next year. Walgreens has increased the dividend at a steady 5-year growth rate of 9.6% and boosted it by another 10% last month, continuing the pace. I expect this to continue for a while as FCF ramps up. WBA also used the drop in the stock to repurchase over $7 billion over the last 12 months and insiders have been buying a ton! All in all, things look very attractive at this price for this blue-chip company that is the most recent addition to the Dow Jones Industrial Average.
Walgreens (WBA) – 2 years
New Investment: Electronic Arts (EA)
Many industries have been benefiting from the increased efficiency of cloud computing and video game makers are no exception. You no longer need the video game console to play games anymore. All you need is the internet which is expanding potential players/customers dramatically across the globe. Over the last 10 years, the number of people playing video games has increased from 200 million to 2.6 billion!
We’re seeing professional leagues, tournaments that are selling out entire basketball arenas and online followings where people watch their favorite players play video games. The whole industry is developing like a professional sport and this trend is expected to continue for years to come.
And here’s the best part for investors: mobile and internet based games are more profitable for the game makers then the traditional console & disk, so not only is the number of consumers increasing (revenue), but the way they are playing is increasing margins (profits). Free Cash Flow for EA was up 10x from FY12 to FY 16.
The 3 main players in the US are Electronic Arts (EA), Activision Blizzard (ATVI) and Take-Two Interactive (TTWO). Each has their own niche, with EA dominating the sports games like Madden NFL and FIFA Soccer, while Activision Blizzard focuses more on action and shooter games. All are attractive in their own right and should benefit from the industry tailwinds but we purchased EA because the stock provided the most attractive entry. They recently delayed the release for one of their best games which will hurt sales for the upcoming crucial holiday season. However, this appears to me like a short-term overreaction that is allowing a nice entry in what should be a continued long-term uptrend.
*All slides from EA presentations
Electronic Arts (EA) – 5 years, weekly
Sold: First Hawaiian Bank (FHB)
We sold our position in FHB last week at a small gain. I’m not a big fan of the banking business model in general since it is extremely fragile. I have no concerns about FHB specifically and still think they’re one of the better positioned regional banks but with the yield curve continuing to flatten I don’t want to own any banks. There’s a time during the economic cycle where banks look attractive but that time is not now.
Thanks for following!
-Nick