Walgreen (NYSE:WAG) reported results that showed the impact of a mild flu season and lower prescriptions due to its contract expiration with Express Scripts (NYSE:ESRX) starting in 2012. Though the company’s prescription business grew more quickly than the industry, margins stayed under pressure because of reduced reimbursement rates and higher SG&A expenses. Its decision to discontinue its business with Express after 2011 has contributed to the stock’s slide of about 20% since June 2011. Walgreen competes with CVS Caremark (NYSE:CVS) and Rite Aid (NYSE:RAD).
Delayed and Weaker Flu Season Hurts, Margins Under Pressure
Revenues rose just 5% last quarter due to a later and weaker flu season, which resulted in Walgreen being able to administer just 5 million shots, compared to 5.6 million during the same period last year. Along with slower revenue growth, the costs also rose with drugstore.com acquisition pushing up selling, general, and administrative expenses by 5%. Reduced reimbursement rates combined with flat front-end margins resulted in lower retail pharmacy margins by 40 bps leading to contraction in the overall gross margin to 28.1%.
Exceeds Prescription Industry Growth
Nonetheless, Walgreen exceeded the prescription industry growth rate by 2.3% last quarter and filed 208 million prescriptions (up 2.5% y-o-y) while prescriptions filed at comparable stores increased 1.8%. The company also increased its retail pharmacy market share to 20%.
Express Scripts Loss Hurts
The retailer lost around $5 billion worth of business in the current year because Express Scripts (NYSE:ESRX) failed to renew its contract. This means that Walgreen will not fill a large part the 90 million Express Scripts prescriptions it filled last year despite attempts to retain as much of these prescription sales as possible through direct contracts with large health plans and employers.
After its exit from the Express Scripts network, the company is still hoping to achieve 97-99% of the past fiscal year’s prescription volume in fiscal 2012, which ends in August. The breakup may cost Walgreen nearly $4 billion in revenue next year.
We value Walgreen with a revised $35 Trefis price estimate of its stock, which is in line with the current market price.