Walgreens Boots Alliance, Inc. (NASDAQ:WBA) Credit Suisse 31st Annual Healthcare Conference November 9, 2022 2:00 PM ET
Company Participants
Roz Brewer – CEO
James Kehoe – CFO
Conference Call Participants
A.J. Rice – Crédit Suisse
A.J. Rice
Hi. I’m A.J. Rice, a health care services analyst at Credit Suisse. And we’re really happy to have up next presenting is Walgreens Boots Alliance. We have Roz Brewer, the Chief Executive Officer; and James Kehoe, the Chief Financial Officer of the company.
Walgreens was kind enough to make a major announcement this week to add excitement to our conference, and we’re happy to have Roz come up and give us a little bit of background on that, and then we’ll go to a Q&A session. Thanks, Roz.
Roz Brewer
Thank, A.J. Thank you. All right. So good morning, everyone. And if I begin to chatter while I’m up here, it’s not because I’m nervous, it’s because it’s cold in here. But it’s a beautiful place out here in the West Coast, and we’re glad to be here. And you’re right, A.J., we did give the industry a lot to talk about this week.
We’ve been very active, but it is a really super exciting time for us at WBA. And we came to the Street about a year ago this time and talked about our forward-looking strategy on the business. And we talked about becoming a U.S. centric health care business mired in localizing health care and doing that through primary care delivery. And so it’s exciting to be back in front of the group and begin to talk about the acceleration. And so much of what has happened over the last 72 hours or so has been about accelerating our plans. And in some areas, we’ve even leapfrog our own expectations. So we’re excited about it.
So I’m going to take you through a little bit of the background, and then we’ll entertain some questions. So on our fourth quarter earnings call, we provided detail on our continued execution as we build out our next growth engine. So we talked about leveraging our core, which is our retail business, including the back of our stores, which is our pharmacy dispensing business. And we talked about a new growth engine.
And so it’s exciting to see that our new growth engine, which is a segment that we’re calling U.S. Healthcare, led by John Driscoll. And so many of you all know John as we accelerated our position with CareCentrix. He’s a former CEO of CareCentrix, so we’re glad to have his expertise in aligning with the strategy that we’re in. And what’s so exciting about that is that we had already been working side by side with John and the team at CareCentrix to talk about our 3-year plan. So it was really almost a natural fit for him to join us inside.
But we’re moving really swiftly to really implant our vision for the company. And that vision is to be a consumer-centric, tech-enabled health care provider. And so we’ve made some very important strategic investments. And as you look at those, what I really enjoy and appreciate about this, are these are assets that are best-in-class assets. And it will allow us to continue to grow our health care business and look at us from not only an organic standpoint, but the acquisitive growth that comes along with the investments that we’ve made.
So our fully integrated health care offering brings together a range of solutions across all a full health care continuum, with an aim to improve the patient experience and do that with improving the health outcomes and lowering the cost of care. So these assets are increasingly working together. And so when you look at our segment, it currently covers over 26 million lives cared for through a network of over 12,000 providers in communities nationwide.
And when I talked about leveraging our core, I want you to think about our retail pharmacy business. So retail pharmacy serves as a cornerstone of our health care offering. And we’ll do that through our hyperlocal footprint. And when you think about our stores that are really trusted iconic brands in neighborhoods and ZIP codes across the U.S., around 9,100 stores. And what we admire about our own brand, and our customers tell us every day, is that we’re there for them.
And we’re there for them in so many ways because we’re within 5 miles of 75% of the households across the United States. So those are rural areas, those are metro suburban areas, those are some areas that have been left behind where you would see health care and food deserts in combination, and we’re there for them. We see significant synergy opportunities focusing on expanding our risk business, expanding our pharmacy value proposition and supporting integrated care and driving operational efficiencies.
If you take a look at what this transaction really does for us, it is really accelerating our U.S. Healthcare in terms of scale and profit. And so when you think about this, I want you to walk away thinking about scale and how this differentiates us from maybe some of the other categories of health care that you can think of, health systems, other competitors that are in this space but don’t have the localization that we have in the physical assets.
And so while our existing portfolio of best-in-class assets supports a strong future outlook, the addition of Summit Health, it’s transformational. And it’s really pushing the business to gain both scale and profit. So I want you to think about this investment supporting VMD and enhancing the value across the full health care business and extends our reach. And it ultimately drives strong financial returns for WBA.
We remain the largest shareholder at 53% of the VillageMD entity, adding complementary specialty and urgent care capabilities and creates a leading multi-payer, integrated provider platform to deliver quality and affordable care for all patients.
And it also expands our addressable market, which is really exciting for us, and it more than doubles VillageMD’s sales and adds meaningful scale to their proposition. We see many — really a large number of synergy opportunities, and we project a run rate of $150 million by 2027 through synergies in 2 ways: improving the risk performance at Summit and cost savings opportunities. So broken up in 2 pieces.
And when you think about that, that risk performance at Summit, that’s about 60% of that $150 million in 2027 and about 40% of that is cost savings opportunities. So this transaction is expected to be slightly accretive to WBA adjusted EPS in fiscal 2023. In the first full year of impact, we expect $0.07 to $0.11 of EPS accretion in 2024 and then increasing thereafter.
Summit accelerates the path to profitability for the U.S. Healthcare segment overall. And while we had previously discussed reaching adjusted EBITDA profitability by 2024, we now expect the segment to exit 2023 with positive adjusted EBITDA. Finally, the addition of Summit gives us further confidence to raise our 2025 sales and adjusted EBITDA goals for the U.S. Healthcare segment.
Our sales goal increases by over 30% versus prior forecast, while we expect roughly $1.1 billion in adjusted EBITDA.
So let me tell you a little bit about Summit Health if you’re not familiar with it. I’ve had the opportunity to look at these units prior to this transaction. And then just yesterday being in the city after we closed the deal, I was able to peek my head in a few of the CityMD locations. And it’s a very prideful moment to see the patient that they’re taking care of and then to remind ourselves the role that they play during the pandemic to really offset what was happening in the health systems when they couldn’t care for other patients due to the COVID outbreak, but CityMD was there for them. And I see them still continuing to do that today.
So Summit Health is a patient center and provider-led entity, and it’s really a premier asset. It’s a leading provider in primary, specialty and urgent care and ancillary services. It operates at scale in New Jersey and New York markets, and it has a holistic connected care value proposition. It has a network of 2,700 providers through 350 locations through the Northeast and a small entity in Oregon.
We see primary care as a critical linchpin in managing population health. So that’s why this is significant for us because we started off with this proposition a year ago. And here we are today focusing on driving high-quality care, improving health outcomes and reducing downstream medical costs. Summit has roughly 750 primary care physicians caring for about 600,000 patients. It’s operating over 150 current urgent care locations, and CityMD is a major player in the New York market for immediate care and completing 5 million visits annually.
Urgent care is a key role, plays a key role in the shift to lower-cost care settings, with a roughly 80% cost reduction versus a comparable emergency room visit. And while the platform helps to offset that proposition, it generates referrals to other specialty care. So you can see how this process works in terms of us thinking about when I said we started off with the thought of being a primary care physician provider. This is accelerating us to specialty care and urgent care and creating something that we thought would come next in our model, but it’s happening for us quite early.
The platform also offers a range of ancillary services, including 4 ambulatory surgery centers with a combined 20-plus operating rooms, a full-service centralized lab service, and we process 5.5 million annual test and advanced imaging and radiology capabilities.
So when we think about this combination and what it creates from a care delivery platform, it’s one of the largest unified independent provider networks in the U.S. It has complementary assets. It serves over 7 million patients and leading to really increased relevance between the payers and the health systems. And this also allows us to advance a holistic care delivery process, managing more of total health spend than we were capable of doing prior to this acquisition.
So when we leverage VillageMD’s value-based care expertise, this will accelerate Summit’s journey to achieve success under risk-based models. So think about Summit is a commercial fee-for-service business and Village being strongly into value-based care and the upside between those 2 entities as they share a common objective to advance towards value-based care.
Like Village, Summit operates a multi-payer platform under which the companies can deliver high-quality affordable care to patient populations, and then the economics improve over time. We expect run rate synergies of $150 million by calendar 2027 in addition to accelerating Summit’s transition to risk. So we expect sizable cost synergies in that area.
So let’s talk about the immediate accretion to WBA. So as a result of this transaction, we’re raising the fiscal ’25 sales goal for U.S. Healthcare to $14.5 billion to $16 billion, which represents an increase of more than 30% versus the most recent increase that we just mentioned in our — as we were closing out our year in fourth quarter earnings. We mentioned $11 billion to $12 billion goal. We are now advancing to $14.5 billion to $16 billion by fiscal ’25. On a combined basis, VillageMD and Summit are expected to comprise roughly 2/3 of our total U.S. Healthcare segment sales in 2025.
So let’s look at the sales outlook for the business. When you look at the sales outlook, this shows you that roughly — raising the fiscal ’25 adjusted EBITDA goal for the U.S. Healthcare to roughly $1.1 billion, you’ll see that this represents an increase versus the $500 million to $700 million goal that we discussed in October, and it represents mid-to-high single digits improvement and also the shift to risk arrangements and unlocking synergies across the business.
So let me close, and then we’ll get into a couple of questions just going a little bit more into the EBITDA outlook for you. So again, I’ll mention that this is highly strategic for us. It provides scale. It’s transformational for both VillageMD and for WBA to advance our vision and our strategy ahead of our plan.
It creates the largest unified independent provider network, it enhances VillageMD’s scale to primary care and expands our total primary care physicians by over 50%, while multi-specialty and urgent care capabilities increase the TAM on this, the addressable market. So significant synergy potential, accelerates Summit’s journey to risk. The deal brings strong financial returns to WBA and is immediately EPS accretive. As we mentioned, we were going to be very strategic about how we use the capital that we have available to us at WBA, and we will exit 2023 with positive adjusted EBITDA. So it’s been structured for maximum impact and flexibility while maintaining a majority ownership position by WBA in the new combined entity.
So I want to thank you all for joining us on this conversation. I’m going to turn it over to A.J. to go into a little bit of Q&A.
Question-and-Answer Session
Q – A.J. Rice
Well, that’s great. And thanks for that run-through. That’s very helpful. Maybe just to follow up on some of the slides there. So part of your synergy was talking about integration.
I’ve always thought, and I don’t have a lot of information because they’re private companies, that the VillageMD model was one way; the CityMD model more urgent care, like you said; and then Summit, more of a comprehensive provider, a multispecialty. Is the integration, is that more at a top level? Or is those businesses really going to come together? And just sort of wonder, are there going to be sort of 3 separate entities that move forward?
Roz Brewer
Sure. So let me talk a little bit about the structure. So the structure will be held at the top by the VillageMD team led by Tim Barry, who will be the CEO and President of the full entity. And then you’ll see segments under Tim in the first couple of years while we work on merging the complements together. So you’ll see the Summit piece on one side with CityMD, and that would be ran by that original team.
We’re going to retain the founders of Summit in the business as we translate this across all the rest of the Village units. And then you’ll have the original VillageMD on the other side.
You’ll continue to see us merge together. The work — the most critical work is to get the commercial business at Summit to transform over into value-based care. And that’s the work that you will see. So you may see some technology ties together, consumer patient data tied together, those kinds of things so we can start working the equation around value-based care.
A.J. Rice
And that move to value-based care, is that something they’re already doing? Or is that something that Village brings in expertise to develop on?
Roz Brewer
Yes. Village brings that expertise to the new entity. Summit had intention to do there. The expertise lies though with Village, and Village has the model for that.
A.J. Rice
Okay. That’s good. Have you thought about how you would report this? Are you going to report this as just one VillageMD entity or within the overall of Walgreens Health? Or how does that — what will it look to the ex — outside world?
James Kehoe
Yes. We’ll just continue as today to report one segment, U.S. Healthcare. And then depending on the timing of an IPO of Village, that’s the first time we’ll expose the full financials. But we did give the numbers in the presentation. We estimate that the combined entity on a full year basis pro forma is about $7 billion of revenue and low single-digit margins. So you’ve got low-teens EBITDA margin on the Summit business, and Village is still losing money on EBITDA as it scales up its clinics. So — but this is immediately profitable in calendar year ’23.
A.J. Rice
Okay. And so that raises the question about — you mentioned IPO. What — how does that decision made as to how they move forward? You guys have a significant — well, you got a majority ownership but then you’ve got a significant position on the board. Do you have a say in that?
Roz Brewer
We do.
A.J. Rice
And we always ask, you have any kind of right of first refusal for anything they do?
Roz Brewer
Yes. So we don’t have right of first refusal. But you’re right, we have 53% ownership. We have the majority Board seats on the Village entity. I’m actually a member of the Board.
So those kinds of strategies come to the Board, and we’ll have the opportunity to not only just vote in a normal governance setting but also to influence it because we’re sitting there with them on a quarterly basis as Board.
A.J. Rice
Okay.
James Kehoe
And the beauty of this is we will have 2 sources of capital once there is an IPO. The second part is, I think it will make transparent to the markets via the tracker stock, the value of our portfolio. If you look at the — you got $1 billion of EBITDA the year after you would potentially do an IPO on $15 billion of revenue.
Look at some of the multiples of transactions for private PCPs recently, and you could argue that in ’25, the value of our health care business is bigger than the market cap of today. So I think there’s many reasons why we want to do an IPO plus access to dedicated capital. And I think we said this when we originally invested last — we’ve increased our investment last year. We said we strongly believe that the management team should have incentives that are directly related to the primary care physician business they have. So having them incented on that stock value is a powerful thing.
A.J. Rice
Okay. And is maintaining a majority position important when you start to think about an IPO and things like that?
Roz Brewer
Yes.
James Kehoe
Yes.
A.J. Rice
Okay. All right. When you think about the whole of Walgreens Health, is your vision right now that the business will continue to run? I mean it’s not obvious to me that there is a reason to integrate what Village is doing with Shields and with the other pieces. But do you see that continuing to run as separate entities?
Roz Brewer
Yes. I think what you could imagine from us is, imagine a day when we can really look at that health care consumer and do full wraparound services. So the ability to attach that consumer once they hit a Walgreens store to fill a prescription. And if it’s a colocated environment, then the primary care physician is an opportunity for them. And then we have the post-acute care business on the tail end of it. So we are threading together a continuum of care.
Now Shields is a separate entity that really supports our core business. If you recall, we said we would leverage the core. So the ability to grow the fastest part of pharmacy, which is specialty care, gives us a chance to do some work on the — in the health systems for specialty pharmacy. So think about that in specialty pharmacy. But I imagine there’s a day when that also connects to the business.
I will mention, too, that CareCentrix being an in-home care business and the VillageMD piece, just imagine how those 2 can connect together. What you might realize right now is that we probably — our next focus area will be what technology do we utilize to create the best thread for the consumer to be in control of their health and utilize all of our health care services.
A.J. Rice
And several different things that I want to ask you about. But it did seem like when you first unveiled this that there might be one more leg to the story that you were thinking about. And often, people tend to gravitate toward that technology-enabled provider enablement. Is that still — that potentially could be another leg that you would add to this.
Roz Brewer
That’s exactly right. That would be the next leg. And in that scenario, there may be some areas where we build and some where we buy.
A.J. Rice
Okay. Okay.
James Kehoe
But it’s unlikely to be as big a transaction.
A.J. Rice
Okay. Yes. When you think about what you were originally doing with the rollout of VillageMD, there was a focus, not primarily necessarily, but a big — a meaningful part was to colocate, to have some tie-in with the Walgreens stores. Now you’ve got these other 2 entities, will that be incorporated in their go-forward? I don’t know how many entity — how many locations they’re even adding at this point. But to the extent they add, will that be part of the story?
Roz Brewer
Well, we’ll have 200 colocated facilities by end of year. And then we’re continuing to grow those. We’ll get to roughly about 600 probably by 2025, ’26, that time frame. The one thing that we are thinking about right now is considering how do we go at this in an asset-light model because we’re learning how to tether the conversation together. And so you may see us come back and say a certain amount that are colocated and a certain amount that are tethered together through some type of form of telehealth.
So we’re evaluating that. Now there’s also a chance for us to — we already had some unique models out in the marketplace of very small Walgreens units. And so could we also build a different model that is a small drugstore with a pharmacy or a virtual pharmacist or a kiosk?
A.J. Rice
Okay. Okay.
James Kehoe
And then Summit gives an opportunity because it’s a multispecialty business. So we may consider larger Village practices that incorporates some kind of specialty services within our broader — so a broader footprint. So we’re looking specifically at the NPV per patient as we optimize the capital allocation model.
A.J. Rice
And when you’re thinking about the accretion of the deal and I think none of the possible synergies with the Walgreens store and the core business, are they in there?
James Kehoe
That’s a good question because the $150 million we’ve set as synergies is purely Village with Summit and we haven’t assessed in detail. We think there will be large synergies with Walgreens, especially in New York, New Jersey. The other part is when you push specialty, multispecialty into Village locations, that’s not fully captured in this number. So what gets us really excited almost is the synergy not fully captured yet.
A.J. Rice
Any way to think about the…
James Kehoe
No. That’s a straight — that’s a no .
A.J. Rice
Okay. Okay. So you funded the transaction with this — with the ABC stake. There’s been a lot of focus on do you maintain the 20% threshold, do you go below that? Maybe give — we were talking about that earlier.
I think it’s worth maybe highlighting what you — how you guys are looking at that a little bit.
James Kehoe
Yes. We got a lot of questions on when do you have to deconsolidate and you lose the equity income. Because we have a Board seat and we only lose the Board seat if we go below 5% ownership, we will continue to consolidate the equity earnings until we go below, if and until we go below 5%.
And we got a great — this was a fabulous transaction also for ABC. We got out with a 4.6% discount at almost a 52-week high and our share price today is higher than when we went into the transaction. Very close collaboration with Jim Cleary, the CFO there. And as you’ve seen, they came in with a $500 million buyback and we were very coordinated with them. And we expect to stay very close in the future as well.
A.J. Rice
Okay. And maybe just to ask a couple of questions here before we end on the base business. I know one of the strategies is to expand the hours and get back to normal hours. And I think on the last quarterly conference call, you talked about you’re at — I don’t have it right here, necessarily at the level of maybe it was 1.4% growth most recent quarter and that, that could potentially accelerate to even 4% or 5%…
James Kehoe
5%, yes.
Roz Brewer
5%.
A.J. Rice
when you’re fully open. I get the question, some of those scripts have moved to other places at this point. How easy is it to get those back? And what do you need to do to do that?
Roz Brewer
Yes. So let me talk about where we are right now. So those 3,000 stores that we’ve been talking about, they’re unlimited hours. And some of those may have been a 24-hour store that now is regular hour stores, and then some have just limited pharmacy hours. We’ve been doing a great job of retaining our front-of-store talent from cashier to middle of store and our pharmacy technicians.
This is about pharmacist and having access to pharmacists. We were about 1,200 pharmacists short. So far, we’ve hired back about 850 pharmacists. And what we’re doing is when we bring those pharmacists in, 2 important factors. First of all, we have worked that brings that customer back. We know when they left, we know what script they were on, the maintenance drug, those kinds of things.
And so this will be a digital data-driven process to bring them back to us. So we’ll know that Jane left the store, when she stopped picking up her prescriptions, and then we can introduce her digitally to her new pharmacist and then have that person come back. But also in that process, we will train that pharmacist for about 4 weeks, start the marketing and then the business begins to return. So we’re seeing — we’re optimistic from what we’re seeing from the 850 pharmacists we’ve hired in the hours that we’ve expanded. We do not have an issue with network access. That would have been a harder pull for us to get that business back, but we’re spending marketing dollars but on a digital basis, which is more efficient spend of marketing dollars.
A.J. Rice
And I think one of the questions in the U.S. retail that has been there all year is front of store because front of store in the last couple of years really benefited from, obviously, COVID testing, vaccines, et cetera. And we had something — it might even turn negative this year. It has been generally positive. I think last quarter, you were slightly negative.
What would you — where are we at there? Do you think we’ve normalized? I know there’s other things going on like reduced shrink is a factor, and there’s some by — products shifts in the way you’re stocking the front end. But give us a sense of where you think we are relative to the last couple of years?
Roz Brewer
Sure. Yes. So versus the last couple of years, our business in front of store was up due to vaccinations and the work around our OTC business, so testing and vaccines. But we’ve retained that customer throughout. And in fourth quarter, we reported front of store up 6%.
Right now, with the flu season as it is, we feel comfortable, really good and solid about our business.
I will tell you that there are some categories that continue to do well for us. Our OTC business is strong for us. Our seasonal business continues to do well, Halloween, Christmas, holidays like that. I will also tell you is that we have a ton of work going on to improve the cost position and profitability per square foot in our stores.
Part of that is around our private label business and going from roughly 16% in our private label offer to closer to 20% to 22%. That’s all margin enhancement for us, and also gives us a chance to get our offering right so we can reset shelves and do the right thing in terms of private label. That private label work will show up in a couple of categories. It’s already pretty deep in OTC, but you’ll see it in some of our food business like snack take and go, nuts, candy, things like that. So we’ve got some opportunity there to keep growing margin, preserve some of the inflation that we’re seeing. And so we feel pretty good that it will be a good business for us.
A.J. Rice
And maybe just I could ask you one specific questions on Boots. But where are we at relative to recovery post pandemic? I know they’re in a little different cycle than where we were in the U.S., but just give us a quick comment on that.
Roz Brewer
Yes. I think in the U.K., mobility is a little bit slow, recovery is slower in the U.K. We’re seeing that on high street in different places. But I am encouraged by the Boots business. Their online business has grown. They’re taking share in other areas where some of the other retailers didn’t bounce back as healthy as we’ve done with Boots. So it continues to be a good business for us.
James Kehoe
And our share of market is about 200 basis points higher than pre COVID.
A.J. Rice
Is that right? Okay.
James Kehoe
Yes. Yes.
A.J. Rice
And that’s across the pharmacy and the…
James Kehoe
Pharmacy is weaker. So we have done less well. But the biggest business by far, 70%, is beauty business…
Roz Brewer
The beauty business.
James Kehoe
Beauty and then health…
A.J. Rice
And that’s where you picked up share?
James Kehoe
200 basis points, yes.
A.J. Rice
Interesting. And there’s been a lot of discussion about a priority to pay down debt and to move forward. Where are you adding that? And how much more would you like to do?
James Kehoe
We think the rating agencies will come out shortly after this transaction, and we probably will end the year with a bifurcated rating. One will be BBB and the other one will be BBB-. Both of them are very, very comfortable that our ’24 and ’25 metrics are very strong. So we’ll come back up pretty quickly to BBB. So we’re not at all worried about this.
There is no impact on interest, 10 basis points, 20 basis points. Yes.
A.J. Rice
Right. Okay. That’s great. Well, thanks so much for presenting, Walgreens. And Roz and James, thank you for your comments.
James Kehoe
Thank you.
Roz Brewer
Thanks, A.J.
A.J. Rice
Next up in the room, let me just give people is, is Elevance. So…
Roz Brewer
Thank you.
James Kehoe
Yes. Thanks all.
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