This isn't a dividend that investors should feel comfortable relying on right now.
Walgreens Boots Alliance (WBA -3.08%) is a stock that is in deep trouble. It isn't trading just at 52-week lows, it's trading at levels it hasn't seen in more than 20-plus years. The company's new CEO, Tim Wentworth, faces an uphill battle trying to turn things around for the struggling business, as well as convincing investors it's worth buying shares of the pharmacy retailer.
Walgreens cut its dividend this year, but I believe the pharmacy specialist should outright suspend it, because that could play a big role in the company's overall turnaround.
Why a dividend doesn't make sense for Walgreens anymore
Walgreens isn't a stock that should be paying a dividend. It's normally when a business is doing well and has strong enough financials to support recurring and regular distributions to shareholders that it makes sense for it to pay a dividend. But with Walgreens, that just isn't the case anymore.
In recent years, it has become common to see Walgreens generate insufficient free cash flow to cover its dividend payments.
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By slashing its dividend nearly in half this year, Walgreens has reduced how much it needs to allocate to its recurring payouts, but it's still too much of a burden for the struggling company. In three of the past five quarters, Walgreens has reported negative free cash flow.
Trying to focus on growth while paying a dividend could be a recipe for disaster
In recent years, Walgreens has been pursuing an aggressive strategy that involves the launch of hundreds of primary care clinics at its locations. Healthcare remains a key growth opportunity for the business, but that's also going to require a lot of resources, including cash, for the company to pursue that, which could exacerbate an already challenging financial situation.
Walgreens recently said that it would be "simplifying and focusing the U.S. healthcare portfolio" in an apparent sign that it might scale back its efforts, at least to some extent. The company also only recently achieved profitability in the segment, reporting an adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) profit of $23 million for the period ending May 31. While it's not a true accounting profit, it's a step in the right direction. It also highlights just how much more effort management still needs to put in for this business to be profitable.
Suspending the dividend would free up a lot of money for Walgreens
Walgreens can still afford to pay its dividend -- for now. But given the company's lack of growth in recent years, slim profit margins, and disappointing free cash flow, there's a lot to fix and not a lot of resources to help make that happen. Walgreens reported cash and cash equivalents of $703 million as of the end of May. Its total current assets of $16.3 billion are far below the company's current liabilities, which total more than $25 billion, meaning it has a negative working capital. This necessarily implies the company is facing problems meeting its short term financial obligations.
The dividend still costs the business $216 million per quarter, or roughly $864 million over the course of a full year. That's after Walgreens already slashed its payout. The simpler option would be to suspend it entirely and not have to worry about the dividend for now, because there are arguably much larger concerns.
Until the dividend is suspended, investors should steer clear of Walgreens
I suspect many dividend investors likely aren't rushing to buy Walgreens shares right now. While a near-9% yield may look attractive, there's not a whole lot of benefit to collecting that kind of payout when the stock's losses could wipe out that income anyway. And it's hard to be too optimistic about the long run for Walgreens given how tough of a situation the business is in today. Investors only need to look at rival Rite Aid, which filed for bankruptcy protection last year, as a reminder of how bad things can get if it isn't able to turn things around quickly.
The dividend doesn't matter if the business isn't on solid financial footing. The priority should be for Walgreens to get its house in order and strengthen its financials, and only then should it consider paying a dividend. Investors who buy the stock for its dividend today are taking on enormous risk, because there's little assurance that the company will be able to afford to pay it for much longer. Even if it can, the shares' troubling performance could negate any income investors generate from the dividend.
Walgreens is a risky stock to own, arguably too risky for most dividend investors to consider. One way it can set itself up for a better future is by parting with its dividend entirely. It may not be the news income investors want to hear, but it can go a long way in helping turn things around, and that's the most important thing for investors in the long run.
David Jagielski has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
