Can Pharmacy Retailers Finally Stop Worrying About Generic Price Inflation?

+13.66%
Upside
77.57
Market
88.17
Trefis
CVS: CVS Health logo
CVS
CVS Health

Drug retailers have had to deal with thin margins for a while now, owing to a combination of factors. As generic drug prices have inflated and reimbursement rates have remained flat, pharmacy chains have posted lower profits. A building backlog of generic approvals at the FDA kept new suppliers away for longer and resulted in a sustained price increases. Even lobbying with the legislation for faster updates to the generic reimbursement limits doesn’t seem to be working. Meanwhile, most pharmacy chains have shifted focus on to other segments such as beauty products and retail clinics in search of profitability.

The tide seems to be turning, however, as indicated by latest data on generic prices and FDA approvals. While generic prices are still increasing, fewer drugs have increased in price and also by lower amounts in Q2 2015 than they did an year ago. The pace of FDA approvals for generic drugs has also picked up in 2015 and could ease the inflation if the trend continues. It is an encouraging sign for all the pharmacy chains, especially Rite Aid (NYSE: RAD), whose margins are much lower than key competitors, Walgreens (NASDAQ:WBA) and CVS Health (NYSE:CVS), mainly due to smaller scale and lower bargaining power with drug manufacturers. Additionally, given Rite Aid’s high investments in store remodels and acquisitions, its need for capital is higher and a decline in margin pressure will be a welcome relief.

Lets take a closer look how trends have changed in the last few quarters leading to the decrease in price inflation.

Relevant Articles
  1. Should You Pick CVS Stock At $75 After A 6% Fall This Year?
  2. Is CVS Health Stock Undervalued At $70?
  3. Will CVS Health Stock Recover To Its Pre-Inflation Shock Highs of $110?
  4. Higher Costs To Weigh On CVS Health’s Q2?
  5. Should You Buy CVS Stock At $70?
  6. Will CVS Stock Rise Post Q1?

Fall In Drug Acquisition Costs

The Drug Channels Institute conducted a study using the drug acquisition cost data [1], which the Centers for Medicare & Medicaid Services (CMS) collect and publish. Similar to what was seen an year ago, half of the generic drugs in the sample increased in cost and the other half decreased. However, the average increase was a mere 2.6% this year (Q2 2015) compared to a 25.7% increase in the same period an year ago. More than 70% drugs had increases of less than 10% in Q2 of this year, compared to under 50% drugs an year ago. Considering multi-fold price increases seen last year, this is a significant slowdown in the price inflation. More detailed analysis of the price changes can be found here.

Generic_Drugs_April2015_vs_July2015

Generic Approvals By FDA Have Accelerated in 2015

Price increases in a particular industry usually attract new suppliers resulting in an increased competition, thereby bringing the prices back down. This wasn’t the case with generics because stricter regulation by the FDA limited the supply. In the past few years, FDA has been slow on granting approvals for generic manufacturers which led to a build up of applications. According to an analysis done by Randall Stanicky at RBC Capital Markets, the backlog at FDA grew from 2,866 ANDAs (Abbreviated New Drug Applications) in 2012 to about 4,000 by 2014.

More recent observations, however, indicate that the pace of approvals has picked up in 2015 and if sustained for the rest of the year or beyond, could resolve the supply issues and ease pricing pressure. Furthermore, faster approvals are likely to draw more suppliers, accelerating the deflation. While the FDA does its job, pharmacy retailers are busy doing theirs, as they continue to aggressively lobby for changes in legislation related to reimbursement rates. Either way, the pharmacy industry has seen the worst of price inflation and it is only going to get better with time.

Refer to our posts on generic price inflation and reimbursement rates for more detail on the topics.

View Interactive Institutional Research (Powered by Trefis)

Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap

More Trefis Research

Sources: Drug Channels Institute

Notes:
  1. Drug Channels Institute []