With The Highest Generic Purchasing Power, Walgreens To Benefit From Rising Generic Sales

In the last one to two years, we have seen a rising number of collaborations between retailers and wholesalers in the pharmaceutical industry. Early last year, AmerisourceBergen (ABC) entered into a 10-year agreement with Walgreens (NYSE:WAG) and Alliance Boots. In December 2013, CVS Caremark (NYSE:CVS) signed a 10-year joint venture with Cardinal Health. McKesson successfully acquired drug wholesaler Celesio in January this year. By consolidating the market, the collaboration between wholesalers and retailers helps streamline the distribution of pharmaceuticals and increase supply chain efficiencies, in turn improving efficiency of the healthcare system.

With 8,681 stores, Walgreens is the largest drugstore chain in the U.S. In August 2012, it completed an initial 45% investment in Alliance Boots, the largest European pharmacy-led drug retailer, with an aim to create a global pharmacycompany by expanding its operation in new markets including Europe, China, Latin America, etc. Walgreens’ agreement with ABC allows it to jointly source generic drugs and generate logistical efficiencies. By combining its distribution in the United States and Europe with ABC, Walgreens will be able to negotiate better prices for generic as well as branded drugs.

In this article, we discuss how the deal with ABC can help Walgreens benefit from the expanding generic drugs market.

Our price estimate of $64 for Walgreens is at a slight discount to the current market price of $70.

View our analysis for Walgreens

The U.S. Market Has Shifted Towards Generics

In the last few years, the U.S. market for medicines has shifted more towards generic drugs as a significant number of patents expired for major brand names. The branded pharmaceutical business has seen tens of billions removed from the market annually by patent expiry. ^[1]

The total generic dispensing rate, which factors the percentage of generic drugs in a consumer’s prescription, grew to 78.5% in 2012, from 74.1% and 71.5% in 2011 and 2010, respectively. The generic wave peaked in Q1 2013 and hit a trough in Q1 2014. Despite slower substitution in the last few quarters, an estimated $15 billion worth of branded products will come off patent in the next two to three years, opening them to competition from generic drugs. ^[2]

Walgreens Has The Strongest Generic Purchasing Power

McKesson, Cardinal and AmerisourceBergen distribute more than 80% of all of the drugs in the United States. ^[3] AmerisourceBergen, which was the third-largest drug distributor in the country, became No. 2 as a result of the deal with Walgreens and Alliance Boots, replacing Cardinal Health. ^[4] Walgreens will now be able to leverage the scale of ABC and Alliance Boots to buy generic drugs at cheaper prices in the U.S.; and expand aggressively in the European market, where generic drugs are underutilized. Walgreens is now also better positioned to leverage pharmacy growth in Asian markets.

The supply agreement with ABC includes the distribution of branded, generic, and specialty pharmaceuticals to Walgreens’ retail stores, mail order and specialty pharmacies. The distribution contract initially included branded pharmaceutical products that Walgreens historically sourced from distributors and suppliers. However, starting 2014, ABC was supposed to increasingly assume the distribution of the generic products that Walgreens has historically self-distributed. Post the ABC deal, the Walgreens-ABC combined generic purchasing power is estimated to be the highest, at around $12 billion.

Generic drugs are comparatively lower priced but offer higher gross margins (approximately 50% higher) than branded drugs, for both wholesalers and retailers. With leading players collaborating with each other, the lower number of buyers in the industry can put pressure on gross margins of generic manufacturers, forcing them to lower the prices even further. Retailers (such as Walgreens) in turn can pass on this cost saving to retail customers.

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1. Cardinal Health and CVS Caremark strike a deal on generics distribution, Pharmaceutical Commerce, December 12, 2013 [↩]
2. CVS Caremark’s CEO Discusses Q2 2013 Results – Earnings Call Transcript, Seeking Alpha, August 6, 2013 [↩]
3. Collaborative sourcing: Leveraging massive generic discounts, Drug Store News, February 18, 2014 [↩]
4. Deal Transforms Global Pill Pipeline, The Wall Street Journal, March 20, 2013 [↩]