Walgreens was recently downgraded by Standard and Poors from “A” to “BBB”, which is a 3 grade move, falling past “A-“ and “BBB+”. This is significant as WAG had generally traded at a 15-25bps premium to CVS, solely based upon their superior credit rating of “A” compared to CVS at “BBB+”. As Walgreens now falls one grade below that of CVS, it is reasonable to think that CVS will begin to gain a pricing premium of 5-10bps, which would equate to a total re-pricing of WAG in the 20-35bps.
The sensitivity of this is quite significant, as generally these two dominant drug store chains sign long term leases with little or no rental increase, therefore appreciation of value is solely reliant on compressing cap rates, conversely any increase in cap rate will have an immediate negative impact on the disposition value.
The probablility of default at a “BBB” rating is still a nominal 2%, however that is a 250% increase from their former “A” rating. The current “BBB” rating remains just one grade above a “junk bond” rating of “BB+”, a critical threshold for any major corporation.
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