March 30, 2017

Uniform Accounting Highlights WBA’s Adjusted EPS is greater than as-reported EPS, and expected growth rates support higher valuations


  • WBA’s traditional EPS is materially distorted by the treatment of operating lease expenses on the as-reported accounting statements
  • After making the appropriate UAFRS adjustments, EPS’ has been significantly greater than the as-reported EPS historically at $4.66 LTM vs traditional EPS of $3.78
  • Adjusted EPS growth has also been greater than as-reported EPS growth at 9% on an LTM basis, versus traditional -9% EPS growth
  • Materially stronger EPS’ at strong growth rates indicates that the firm is likely fairly valued at worst, with an Adjusted PEG ratio of 1.0x

Walgreens Boots Alliance, Inc. (WBA) is expected to release their Q2 2017 earnings of $1.27 per share on 4/5, representing a 47% growth rate over the same period last year, though this expected growth has failed to drive material stock price improvements, with shares trading in a range between $75 and $90 over the last year and a half.

Part of the reason for this, is that over the past four quarters, as-reported earnings have been weaker year-over-year, with EPS on an LTM basis of $3.78, representing a 9% drop from the prior four quarters.  Even if one were to adjust for special items, the firm only saw EPS remain flat year over year. Projections for NTM EPS growth (Q2 2017-Q1 2018) are a significantly greater in comparison, expecting a robust EPS of $4.72, which is a 25% improvement over LTM EPS, though only a 14% improvement over four quarters ended Q1 2016.

However, after making appropriate adjustments under the Uniform Accounting Financial Reporting Standards (UAFRS), it is apparent that not only are these growth rates a result of actual continued economic improvements (versus a rebound from weaker levels), but adjusted EPS (EPS’) is significantly higher than as-reported financials suggest, justifying higher Adjusted valuations.

Specifically, under UAFRS, Adjusted EPS (EPS’) grew at a 9% rate over the past four quarters, materially better than as-reported earnings shrinkage of 9%, and is expected to grow at a robust 21% growth rate over the next four quarters.  As the charts below highlight, this is significant, as EPS’ is already well in excess of traditional EPS, indicating investors may not realize the true earnings power WBA currently generates.  WBA’s EPS’ is expected to reach $5.64 next year, up from $4.66 for the four quarters ended Q1 2017, and $4.27 in the four quarters ended Q1 2016, which are in excess of as-reported EPS by an average of 15%. Additionally, once the appropriate adjustments have been made, WBA has consistently grown earnings for the past three years, contrary to as-reported metrics that indicate the firm’s EPS fell in the last four quarters. Given the firm’s relatively modest valuations relative to as-reported EPS, it is likely that the firm’s true EPS’ would support an even greater premium.

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The quarterly results show a similar trend, as not only have quarterly EPS’ grown at a greater rate than traditional EPS on a year-over-year basis, but they are also significantly higher (20%+ greater) already. Given that these trends are likely to continue into the foreseeable future, valuations may be discounted at current levels.

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UAFRS, Uniform Adjusted Financial Reporting Standards, call for removal of distortions from issues like the treatment of operating leases. Once removed, it is apparent that real earnings growth would likely support even greater valuations should it be sustained.

UAFRS vs. As-Reported EPS

Investors make major decisions about which companies to own based on quarterly company earnings, the most common metric mentioned in traditional corporate investment analysis.

However, more often than not, the earnings that companies report in any given quarter can swing wildly and lead investors to completely wrong conclusions, because GAAP and IFRS rules force management to report results in ways that are not representative of the real operating performance of the business.

While there is a case to be made that some management teams can use “creative accounting” to adjust numbers, the research would show that more often than not, the real problem is with the accounting rules themselves, not management’s use of them.

Impact of Adjustments from GAAP to UAFRS

There are several adjustments required to make earnings representative of a firm’s true cash flows. For WBA, the most material adjustment is related to operating lease expenses.

WBA’s operating lease expense is material. The decision management makes between investing in capex and investing in a lease is not a decision between an expense and an investment, but rather a decision in how management wants to finance their investments. If they would rather spend cash up front for the asset, they will spend capex. However, if they want to spread the cost of the asset over several years, they will instead choose to lease the asset. That said, as-reported accounting statements treat one as an investment, and the other as an expense that does not impact the balance sheet. Because WBA materially spends on operating leases, as-reported metrics like EPS can materially understate the firm’s earnings power.

UAFRS-reporting adjusts for these traditional accounting distortions by treating all operating leases as an investing cash flow. This simple reclassification removes a tremendous amount of accounting noise related to investment activities and improves investors understanding of the operating earnings of a business.

Higher than reported earnings and earnings growth support higher valuations

WBA is currently trading at a 21.9x UAFRS-based P/E (Fwd V/E’), which is around the historical averages, but still well below levels seen pre-2007 when the firm was still steadily improving profitability.  Assuming the firm can maintain next year’s expected 15%-20% levels of growth, the company’s PEG ratio is around 1.0x, indicating the firm is likely fairly valued at worst.

Additionally, as WBA has consistently grown its Adjusted EPS for the last three years, and currently has Adjusted EPS +15% in excess of as-reported earnings, there is the potential that going forward the market will recognize and reward the firm’s true level of profitability.

By using Uniform Adjusted Financial Reporting Standards (UAFRS), investors see a cleaner picture that distorted GAAP and IFRS metrics cannot show. By standardizing financial reporting consistently across time and across companies, corporate performance and valuation metrics improve dramatically. Comparability of a company’s earnings over time, trends in corporate profitability and comparability in earnings power and earnings growth across close competitors and different sectors becomes far more relevant and reliable.

To find out more about Walgreens Boots Alliance, Inc. and how their performance and market expectations compare to peers, click here to access the open beta of the Valens Research database.

Our Chief Investment Strategist, Joel Litman, chairs the Valens Equities and Credit Research Committees, which are responsible for this article. Professor Litman is a recognized global expert in advanced financial statement analysis, corporate performance, and valuation.