Walgreens Boots Alliance

I am looking at Walgreens Boots Alliance (WBA), and it seems interesting.

Investment Thesis

  • WBA is a large ($125B sales), growing (5-10%), and reasonably profitable company (ROE: 10-15%).
  • financially and operationally conservative: Its current (debt + liabilities)/EBITDA = 1.5 – 2.5x, depending on how you deal with leases. It pays a consistently growing dividend.
  • operationally conservative: It has avoided the acquisitive path of CVS (where debt/EBITDA is closer to 4-5x), choosing instead, to partner and collaborate. This strategy may attract “partners” wary of the CVS’s ecosystem.
  • horizontal and vertical integration: Consolidation is underway in the industry. WBA is iterative, and works in small steps. It bought a slice of Rite Aid stores, and a quarter of drug distributor Amerisource Bergen. In 2014, Walgreens bought Boots Alliance, which brought in a new CEO.
  • owner operator: CEO Pessina is a well regarded operator, with skin in the game. He bought a chunk when share price was in the $80s.
  • recession resistant, WBA was cash flow positive through the Great recession; plus their balance sheet is conservative.
  • risks are regulatory (can adapt), and Amazon (probably overblown given the complexity and low margins)

Quick Valuation

FCF/sales is steady and approximately 4%. Over periods of time, FCF exceeds net income by about 25%. This is especially so, if you normalize recent flurry of M&A.

Using a growth rate of 5%, discount rate of 12% and FCF of $6-6.5 gives a value of $90-$100/share using a terminal growth model.

It is cheap relative to its past P/S: 0.5 (historical 0.75), EV/EBIT 13.5 (historical 16.5), P/E 16.5 (historical 20). If they mean revert, they all imply a target price close to $100.


  • Comparison with other retailers: Walmart – $505B, Amazon – $193B, Costco – $140B, CVS – $185B, TGT – $72B.
  • Sales growth at Walmart and Target has trickled down to the 0-2% range, while that at CVS and WBA has been steady in the high single to low teens.
  • Rewards Program has about 90M members. This is valuable data.
  • Founded in 1909, invented milkshakes, and popularized soda fountains in the middle of the store.


  • RGA Investment Advisors slide deck on WBA, and Elliot Turner‘s twitter posts, were helpful in understanding the game WBA is choosing to play, compared to CVS.



Some Updates

This has been an interesting year so far. Despite being 30% in cash, I am down about 1.5%, which is more than the market.

Two relatively large positions are down significantly YTD. LUK is down nearly 20% ($26.50 to $22), and CFX is down nearly 25-30% ($40 to $30).

LUK made quite a few changes including changing its name and ticker to JEF, selling a large part of National Beef and all of Garcadia, and bought back nearly half a billion dollars in stock. For a $8B market cap company that is nearly 6%. While LUK or JEF has been a frustrating stock to hold, I can’t help thinking management is trying to do the best they can. I still think this is a stock worth north of $30, and am happy to hold on.

CFX expects to earn between $2.05 – $2.20/share (slide 20 on Q1 2018 presentation, link) for 2018. It seems like it is getting itself back on track. At a 18x multiple, they should be worth $36-40/share. Plus, it is a cyclical business that gets better with time, and it seems like a lot of its end markets are improving.

My most frustrating holding has been ALJJ. 2018 has been absolutely disappointing for reasons outlined in my last post on the company. Since then an additional “meh” quarter has gone by. The stock has halved from $3.15 at year end to $1.50-$1.60 last week. The company issued updated guidance calling for adj. EBITDA of $31-34m compared to $36-39m at the start of the year. If I assume interest, capex and tax to be on the higher end of previous guidance ($10m, $9m, and $1.5m), and divide by number of shares (37.9m), I still come up with a FCF/share of 28c – 35c. At 10x FCF, the stock could be worth twice its current price! The valuation was too compelling to pass up. I held my nose, and increased my position by 40%. I currently own 7000 shares at an average price of $2.81.

If the price of Under Armour holds steady, I will have escaped another holding full of drama with a small profit (5%). I started chasing UA to teach myself some options trading, and ended up buying at $20 and $16.50. The stock got halved from $20 to $10 over 2017, and has now jumped back to near $20. I think it is easily worth $15-$20, and might, with good execution, be a worth several times more. However, with the market getting choppy, I thinking there are more lower risk propositions available than last year.

Brookfield Asset Management

Brookfield Asset Management (BAM) is well known among value investing circles. It is a leading global manager of real assets.

It is easy to get lost in BAM’s complicated structure. It is both: an asset manager, and an asset owner. It owns significant portions of publicly traded names (listed issuers like BPY, BIP, BEP, BBU), and private flagship funds that it manages like a traditional asset manager.

BAM eats its own cooking, and it is a good cook.

The funds and companies have provided superb returns in the past. As a part owner, some of these earnings and distributions flow to BAM. As an asset manager, it charges other investors and partners sharing the ride (fee bearing capital), and earns a performance-based carried interest (like a 2 and 20 hedge fund).

There is a lot of great commentary and information on BAM. Here is a small subset:

  • The Brooklyn Investor looked at BAM in June 2015 and did not seem particularly impressed by the value proposition
  • “Value by George” revisited it around that time, and had a more favorable take
  • There is a decent (and recent) stab at valuing BAM on SeekingAlpha by Eric Sprague
  • The 2017 Investor Day presentation provides a fine overview of the key drivers

Here are some important takeaways:

  • It is hard to argue that they have great management. BAM is a well run machine. The annual and quarterly (!) letters are a treat to read. The business is global and complicated, but the management seems quite transparent. They have strong culture, and a deep bench.
  • The business model is unique. As asset managers, they can leverage their investment gains on the assets they own by levering it with outside capital. They also earn a base fee on the outside AUM.
  • There are structural tailwinds, as allocations to real assets are increasing.
  • BAM is also a growth story. The AUM has grown 10%/year (2012 – $158B to 2017 – $258B)


The 2017 investor presentation provides a glimpse at what the company might look like in 2022. They value the asset owner and asset manager parts separately, and add the two portions together.

I am unsure if one can come up with an estimate of intrinsic value without finding the intrinsic value of its holdings separately.

It is preferable to be simple and approximately right, than to chase down every moving part in this intricate operation.

In the presentation, they subtract the debt/corporate capitalization ($10B) from the total invested capital ($65B) for a $55B asset owner value.

For the asset management business, they slap a 20x multiple on fee related earnings ($1,689M * 20 = $33.8B) and a 10x multiple on carried interest (10 * $1, 054M = $10.5B). Adding them and dividing by the total number of units gives a value per share of $100.

I prefer to tone this number down.

For example, assuming ~3% dilution in the number of shares brings this number down to $80/share. Nevertheless, at today’s prices of ~$42, even the lower number implies a nearly 14% return.

What about just looking at the 2017 numbers? Using a similar methodology, the asset owner stake is worth $38.5B – $9B = $29.5B. The asset manager stake is worth $14.6B (FRE) and $6B (carried interest) for nearly $50B in intrinsic value. Dividing by the number of shares (1,065M), we get a per share value of approximately $47. Thus, even by this reckoning, shares are about 20% undervalued.

I took this opportunity to start a 1.5% position. I hope to add to the position, as I get more comfortable with it.

A Quick Look at Western Digital

Western Digital (WDC) does storage; it designs, makes, and sells hard disk and flash drives. These are used from PCs/notebooks, consumer electronic products, all the way to enterprise servers.

The company’s 2016 investor presentation, and this 2017 update provide a good overview of the business and opportunities.

WD has a history of bolstering its storage offerings by arguably decent acquisitions. It has morphed from a pure HDD play to a more general storage play over the past 10 years.


The company’s presentation also lays out positive and negative factors.



  • secular decline in PC and notebook industries; but the company expects the storage portion of this market to work out better
  • HDD industry is essentially a duopoly (with Seagate); but overall storage industry (particularly HDD) is cyclical
  • commodity product; no durable competitive advantages


  • in the near term, HDD to remain dominant fraction of total stored data
  • decent management, good acquisition and capital allocation record
  • increased demand due to “big data”, more digitalization
  • datacenters, cloud computing


The company lays out numbers to anchor a valuation.


  • TTM revenues are ~$19.5B (up from $8B in 2008); EBIT is $2.6B (up from $1B in 2008). EPS numbers are noisy, but FCF is indicative of a cash generating business.
  • Share count has increased from 226M to 301M over the past 10 years.
  • Historical tax rate has been 7-12%, in line with future expectations. Probably should not expect tax bill to help much.
  • Total debt is $13.1B (about 2.75x EBITDA), peaked at $17B in 2016. WDC is develering. Interest expenses are currently ~$800M (compared with EBIT of $2.6B). Debt looks manageable, especially when compared to competition like Seagate, which has a much more levered balance sheet.

The adjusted FCF/sales has been 13-14% (in line with target). Sales growth is expected to be low single digits.

If we use FCF/sales = 13%, sales growth = 3%, then FCFF/share = $9.05. Subtracting the $2.75 of interest payments/share, we get FCFE for the next year of $6.30. Using the Gordon growth model with a hurdle rate of 10%, we get a target price of $85.

If we use less conservative numbers (FCF/sales = 13.5%; sales growth = 3.5%, and interest payments of $2.50 from continued delevering), we get a target a target price of $115.

Thus, the range of values is probably between $85-$115. Currently, it is trading below the lower end of this range.




A Pile of MCK?

McKesson Corporation (MCK), founded 1833, is the largest distributor of drugs, medical products, and supplies in the US.

Distributors like MCK connect pharmaceutical manufacturers like Pfizer, Merk, and Bristol-Meyer-Squibb to outlets like Walmart, Albertsons, and hospital pharmacies.

Industry Landscape

McKesson’s fingerprints can be found somewhere on nearly a third of all prescriptions in the US. MCK is a supplier to more than 75% of US hospitals with more than 200 beds. The breadth of their products and services, combined with their geographical scale allows them to offer attractive package deals to their customers.

The US distributor market has characteristics of a mature oligopoly. 90% of the market is dominated by three relatively equisized players.

McKesson  (MCK): ~$30B market cap, ~$200B revenue
Cardinal Health (CAH): $17B market cap, $130B revenue
AmerisourceBergen (ABC): $19B mcap, $150B revenue

As a result, pricing in the US is mostly rational.

While US retail is a $400B opportunity, Europe is a ~$200B market.

MCK has recently been growing its presence in Europe, Canada, Brazil etc., where the distributor landscape is much more fragmented, and opportunities from consolidation abound.

In 2016-17, MCK merged its legacy technology solutions business with Blackstone owned Change Healthcare to form a new IT company. MCK owns 70% of the new firm. This allows McKesson to focus on its core drug distribution business. The end-game is to spin it off as an independent company.

Financial Overview

As of 09/2017, TTM revenues were $202B. However, the margins in this business are brutal. Despite the huge topline number, only $4.5B flowed to the bottomline.

Operating margins are generally in the 1.5-2% range, with net margins slightly over 1%.

It is hard for me not contrast these terrible margins with the fat 15-20% EBIT margins for industrial distributors like Fastenal (FAST) or MSC Industrial Direct (MSM). It is no surprise that FAST or MSM boast impressive returns on capital and equity. The ROIC and ROE for both these industrial distributors is in the 15-25% range.

It might therefore come as a surprise that McKesson also has racked up impressive ROIC (10-12%) and ROE (15-20%) numbers, despite terrible margins.

How in the world is it able to do that?

The short answer is that it plays the Costco game.

If you sell a lot of stuff without using much capital, then you can generate high returns on capital. The sales/capital ratio for industrial distributors (FAST and MSM) is in the 1.5-2.0 range.

For MCK, sales/capital is in the 7-10 range!

ROIC = NOPAT/IC = (Sales/Capital) * (EBIT Margin) * (1-tax rate)
ROE  = NI/Equity = ROIC * (1 - interest/EBIT) * (1 + debt/equity)

If we use normalized numbers for sales/capital (8.5), EBIT margin (1.75%), tax rate (30%), interest/EBIT (10%), and debt/equity (0.75), one can easily see how MCK hits ROIC in the 10-12% range, and ROE in the mid-high teens.

Unlike FAST or MSM, the healthcare market, and MCK by extension, is more recession resistant. It can afford the luxury of running a more leveraged operation to lower its cost of capital and turbo-charge returns to equity (and it does!).

Nevertheless, debt levels remain manageable; the entire debt can be paid off in 2 years from operating cash flows. Indeed, the company is delevering (a little).

MCK has grown topline at a steady 7-10% rate for nearly 10 years now. The business survived the 2008-09 crash relatively unscathed. The share count has declined almost 30% from 290M in 2008 to 214M in the most recent quarter. The company also pays a small dividend (~1%).


  • Although brand Rx drugs constitute a large fraction of the revenue (~60%), generic drugs constitute most of the gross profit (~65%). After a blockbuster 2015 in which the price of Gx increased, subsequent deflation has pressured profits.
  • 2016 was an election year, and drug prices were in the spotlight. These temporary unfavorable pricing dynamics should eventually normalize.
  • There is continued uncertainty regarding the future of healthcare reform, and any regulatory risk that may entail.
  • Customer consolidation (Target/CVS, RiteAid/Walgreens) affects contracts. Their resulting heft implies a weaker negotiating position for distributors.
  • Just recently (11/20/2017), the stock fell more than 3% on a report that Amazon would slice away a significant portion of MCK’s revenue. I think this fear is overblown. Just look at the low margins in the business. They provide a basis to mount a strong defense against Amazon.


If there are no major disruptions, we should anchor expectations close to the return on equity (~15%).

Terminal Model

Let’s use a simple terminal model. TTM revenues were $202B. Since CapEx is modest, we can assume FCF ~ NI (FCF margins 1%), and growth rate of 5% for the next decade or so, and a cost of capital of 9%, we get a TV of $52.7B.

Subtracting the net debt ($5.8B), and dividing by the number of shares, we get an IV/share of $220.

Relative Valuation

Historically, MCK has traded in P/E band of 11x-24x, with a midpoint around 17. For 2018 and 2019, S&P estimates EPS to be $12.14 and $12.98, respectively. At a P/E of 17, this implies a target price of 17*$12.14 = $207.

At current prices of $130-150, shares are attractively priced.

Portfolio Moves: Sold Apple

After 4.5 years, I finally closed my Apple position last week.

I started buying in early 2013 in the low $60s (accounting for the 7 for 1 split). In 2016, I added to the position in the low-mid $90s. For quite some time it was my largest or second-largest position.


No matter how conservative I got, I couldn’t come up with a value below $120. Last fall, I wrote:

The narrative is either “its going gangbusters” or “its going down the toilet”. Right now, we seem to be closer to the latter.

The narrative shifted over the past year, as Apple racked up an impressive 80% run.

As usual, I began selling way too early ($120), and finally exited my last sliver on November 10 at $175. Overall, my cost basis was $71, and my average exit price was $130 and change.

Counting dividends, Apple returned between 18-20% CAGR. Not spectacular, but considering the size of the position, and its relative safety (in my opinion), it is my kind of long-term trade.

At current prices of $175/share, AAPL doesn’t seem to be as great a value.


Last year, Apple earned about $9/share. It has about $31/share of excess cash. Using a conservative 12x multiple on the earnings, and a 20% repatriation haircut on the excess cash, I get a valuation of about $135. If you use a 15x earnings multiple, you can justify paying up $160.

I don’t know what the right multiple is. I hesitate using a high multiple because (i) Apple relies heavily on the iPhone, which regardless of how the winds are blowing currently is subject to disruption/erosion, and (ii) earnings are starting to saturate/grow more slowly.

I don’t think AAPL is grossly overvalued. However, I prefer to sit this one out.

Apple might quite possibly march onward to become the first trillion dollar company. I’ll be happy to watch the fireworks, and cheer on from the sidelines.

Under Dog

Over the past three years, Under Armour’s (UA) market cap has fallen by nearly 80%. Just over the past year, shares have lost 2/3 of their market value.

The most recent quarterly (Q3 2017) earnings report was brutal. Everything that matters was revised downwards. A series of external pressures (North American weakness, price war etc.), and internally inflicted wounds (ERP integration mismanagement etc.) have conspired to make 2017 a year UA would like to forget.

This is what happens when a growth story goes wrong. The sentiment against the company is overwhelmingly negative. The short ratio is around 10-12%, and the days to cover based on normal volumes is now about 15.

Is UA broken for good? Or are its troubles temporary? Will the company plough through this bad patch, and return to “normal”? Is the rational behavior at this time, to fold and cut our losses, or to hold our noses and double down?

Back Story

Previously, I thought UA was worth somewhere in the high teens. That was earlier this year, when the stock was trading near $20.


Since I was learning a new put-writing option strategy, I thought UA – with its high volatility – might be a good candidate to experiment with. I began writing $20 strike puts in Feb 2017, and kept rolling them until August. After Q2 results, the stock dropped to the $15-16 range, and I got assigned my first set (400) of UA shares.

At that time, I revalued UA, and thought the long-term thesis remained mostly intact, and began writing more puts. This time at $16.50 strike. I kept doing this, until Q3 earnings were declared on 10/31. The stock subsequently dropped further, and now hovers between $10-11. The puts are deep in the money, and will likely get assigned when they expire on 11/24/2017 (500 more shares).

All said and done, I now have 900 shares at an average price of $15.50 (~$14k). My total maximum target allocation for UA is $25k (for a 5% position), which means I could more than double my ownership at current prices.


After I factor in the disastrous Q3, and modest improvements over the next three years, followed by a return to industry averages by year 10, I get a DCF value of $15-16.I think this is a conservative estimate.

At current prices of $10-$11, the stock may be undervalued by nearly a third.


Any improvement beyond the currently depressed valuations, any unexpected return to 10-20% growth rates in the near/medium term, and resulting multiple expansion could easily double the target price.

Five years from now, we might look back at this period as a good buying opportunity.