Drug Retail Weekly Notes: Walgreen, CVS Caremark & Rite Aid

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Drug retailer Walgreen (NYSE:WAG) is due to announce its 2Q results on Tuesday. There has been recent speculation that Walgreen may be considering buying Rite Aid (NYSE:RAD) to strengthen its position against reimbursement rate pressure from the PBMs, particularly after splitting with Express Scripts (NYSE:ESRX). Rite Aid’s stock shot past the $2 mark in part due to these rumors last week. Among other developments, CVS Caremark (NYSE:CVS) is closing down its prestige beauty retail stores Beauty360 and the corresponding e-commerce business to focus on the growth of its core CVS pharmacy beauty business. Read more on the updates and and the outlook for the industry.

See our complete analysis of Rite AidWalgreen CVS Caremark

Walgreen

Walgreen, the leading drugstore chain with 8,400+ locations across the U.S, will announce its 2Q results on Tuesday. After its contract expiration with Express Scripts starting 2012, the drug retailer is likely to lose $4 billion in revenues and over 80 million Express prescriptions during the year. Contract loss and milder flu season resulted in weak sales for DecemberJanuary and February with 9-10% fewer prescriptions filled at comparable stores (y/y).

As Medco (NYSE:MHS) is trying to fold into Express Scripts, Walgreen could face the risk of a similar reimbursement rate negotiation with Medco. In the worst case, it could lose more business if the merger goes through, unless it succumbs to reimbursement pressure, which would hurt its bottom line. This has fueled speculation that Walgreen might be contemplating taking over Rite Aid to regain some of its bargaining power against the PBM industry. Read more: Walgreen Earnings Preview: What We’re Watching Tuesday

View our detailed analysis for Walgreen with a $35 Trefis price estimate.

Rite Aid

U.S.’s third largest drug retailer Rite-Aid‘s stock has gained more than 50% value in the last three months amid healthy sales growth, improved revenue guidance, a recent debt refinancing, and most interestingly, rumors that drug retail giant Walgreen (NYSE:WAG) could be planning a takeover of Rite Aid. Read Former Walgreens CEO offers perspective on WAG-RAD merger speculation and What If Walgreen buys Rite-Aid.

The stock shot past the $2 mark following this speculation last week. It also jumped in November last year after analysts at Susquehanna Financial Group suggestedthat it may be a potential takeover target of Walgreen. Read more here - Walgreen Could Spur Consolidation with Rite Aid Deal.

View our detailed analysis for Rite Aid with a $1.45 Trefis price estimate.

CVS Caremark

CVS Caremark, the second largest drug retailer after Walgreens with 7,300+ stores, recently announced closure of all of its prestige beauty retail stores Beauty360 and the corresponding e-commerce business to focus on the growth of its core CVS pharmacy beauty business. The move is motivated by the success of its Beauty Club loyalty program and the performance of its in-house brand Nuance Salma Hayek launched last year. It intends to focus its efforts in the beauty retail sector through its 7,300 strong CVS drugstore network. Read more : CVS Shuts Beauty360 To Focus On Core Beauty Retail Business

View our detailed analysis for CVS Caremark with a $45 Trefis price estimate.

Industry Outlook

The U.S. has an aging population, and as these seniors spend more on drugs, the prescription drugs market in the U.S. is expanding rapidly. The 2010 U.S. health reform legislation is expected to increase prescription drug sales as over 30 million so-far uninsured Americans will gain coverage along with the expansion of Medicaid and Medicare Part D plans.

The expansion of generic drugs in the U.S. market will positively impact retail pharmacy gross margins. Generic drugs have lower costs but higher margins compared to branded drugs and gross profit dollars are approximately 50% higher on generic drugs than on branded drugs. Patents for a large number of branded drugs are due to expire between 2011 and 2015, like Pfizer’s blockbuster Lipitor drug (over $11 billion in annual sales) that lost patent protection November last year. The generic wave will be a huge catalyst to boost industry margins.

However the drug retailers could face greater reimbursement rate pressure if the PBM industry consolidates itself. For example, U.S.’s two largest PBMs Express Scripts and Medco are attempting to merge, pending FTC review. If the merger gets regulatory approval, the resulting entity would not only control more than 35% market share, the consolidation in the PBM industry would also greatly increase their pricing power. Therefore, there is a likelihood of large drug retailers responding with take overs of smaller retailers as a way to regain some of their bargaining power.

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