Don't Over Analyze, This Stock is Too Cheap

By Lee Samaha - October 4, 2012 | Tickers: CVS, ESRX, PRGO, WMT, WAG | 0 Comments

Lee is a member of The Motley Fool Blog Network -- entries represent the personal opinions of our bloggers and are not formally edited.

Sometimes as investors we can over-analyze and spend so much time looking at fine details that we miss the bigger picture. I think this is exactly what many are doing with Walgreen (NYSE: WAG). Every investor is trying to analyze how many of the lost customers Walgreen will regain from the Express Scripts (NASDAQ: ESRX) debacle, but does a debate over the marginal amount really matter when the stock is so cheap? I dont think it does.

Time to Confess

OK, I admit it: I am one of the guilty parties. I hold a position in CVS Caremark (NYSE: CVS), and quite frankly I think Walgreen will find it difficult to win back lost customers from the likes of CVS and Wal-Mart (NYSE: WMT). I even articulated this view in a previous article.

Investors should understand that whole industries are structured around the reason why Walgreen will find it hard to win customers back. Customer inertia is a very powerful force; not for nothing do insurance companies lower premiums on first time buyers in order to increase their hold over them in future years. Customers tend to stick around because they overvalue the hassle of switching. The same principle will be at work here, and CVS and Wal-Mart are both companies that know exactly how to retain customers in their pharmacy businesses.

But Really, Who Cares?

There is a great temptation to get sucked into a Walgreen vs. CVS argument, and then maybe conclude that CVS is better and buy that. But even if you share my view that CVS is the more attractive company, who said you cant buy both stocks?

Even a cursory look at the valuation shows that Walgreen is hardly stretched. Despite the effect on revenue and profitsfrom the loss of the Express Scripts business, Walgreen is still trading on some very attractive multiples. A current PE of 14.5x and an EV/EBITDA multiple of 8.2 is not expensive. It doesnt stop there; the company just generated $2.9 billion worth of free cash flow, which represents around 7.5% of its enterprise value.

The point Im making is that the stock is already attractive on a current basis even without arguing over whether it will regain X percentage of customers. The fact is that Walgreen will recover customers, and Im convinced that the stock (and the sector) have a lot of positive growth drivers.

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Don't Over Analyze, This Stock is Too Cheap