Walgreen (NYSE:WAG) will announce its 2Q results early next week. In the aftermath of its split with Express Scripts (NYSE:ESRX) and a milder flu season, it has posted subdued sales for December, January and February with 9-10% fewer prescriptions filled at comparable stores (y/y). It stands to lose $4 billion in revenues and over 80 million Express prescriptions in 2012.
Even though it is trying to minimize its losses by half in fiscal 2012 through cost-cuts and increased generics utilization, it faces increasing reimbursement rate pressure on its margins from the Pharmacy Benefit Managers. The margin pressure has prompted a fresh round of speculation about the possibility of industry consolidation with suggestions that Walgreen may buy its competitor Rite Aid (NYSE:RAD) to regain some of bargaining power with the PBMs.
Express Scripts Loss And Milder Flu Season Weigh on Results
During the quarter, prescriptions filled at comparable stores have dropped 9-10% (y/y) mainly due to Walgreen’s exit from the Express Scripts network, which accounted for 12.6% of the company’s prescriptions until 2011. There has also been some negative impact due to a delayed and milder flu season which resulted in Walgreen being able to administer just 5.5 million flu shots during this season, compared to 6.3 million last year.
Walgreen is trying to minimize losses by cutting costs and expects to offset around 50% of gross profit reduction in fiscal 2012. However, after having recently concluded its three year $1 billion cost-cutting program, it may find it difficult to cut more costs to cover prescription losses.
Would Walgreen Buy Rite Aid?
As Medco (NYSE:MHS) is trying to fold into Express Scripts (pending FTC review), Walgreen could face a similar reimbursement rate negotiation with Medco. It stands a risk of losing more business if the merger goes through, unless it succumbs to reimbursement pressure on its bottom-line. This has fueled speculations that Walgreen might be contemplating taking over Rite Aid to regain some of their bargaining power against the PBM industry. (Former Walgreens CEO offers perspective on WAG-RAD merger speculation). Rite Aid‘s stock shot past the $2 mark following such speculations last week. Read more here - Walgreen Could Spur Consolidation with Rite Aid Deal.
We currently value Walgreen with a revised $35 Trefis price estimate of its stock, which is 5% ahead of the current market price.