Walgreen Slumps on Express Scripts Uncertainty

The leading drugstore chain Walgreen‘s (NYSE:WAG) stock has reached a new low for the year as its contract dispute with Express Scripts (NYSE:ESRX) threatens to cost Walgreen a large part of the $5 billion business starting 2012, despite all attempts to retain as much prescription sales as possible through direct contracts with large health plans and employers. It conceded that the impasse started to reflect in weaker than expected October sales. The stock continued to weaken in anticipation of script exodus with major analyst downgrades like Credit Suisse, and touched the low after being downgraded by Morgan Stanley. Walgreen competes with CVS Caremark (NYSE:CVS) and Rite Aid (NYSE:RAD).

View our analysis for Walgreen.

Shares Falling in Anticipation of Script Exodus From Walgreen

Shares of Walgreen have fallen more than 30% since it first announced in June that it will stop filling prescriptions for people covered by Express Scripts. With the Walgreen-Express Scripts contract expiring in December this year and still no signs of any compromise settlement, Credit Suisse recently cut its price target on Walgreen to $31 from $42, downgrading it to “neutral” from “outperform”.

The weakened stock tanked to a further low after Morgan Stanley became the latest firm to downgrade the drugstore chain’s shares, downgrading the stock to “Underperform” from “Equal-weight” with a new price target of $29 from the previous $45.

The stalemate threatens to cost Walgreen about $5 billion in annual sales with 90 million prescriptions, or about 7% of its business. Walgreen recently projected the possibility of a loss in 2012 of more than $3 billion in revenue because of the planned loss of business from customers whose prescription drug coverage is managed by Express Scripts. Even though Walgreen is trying to retain as much part of the prescription business possible, it still may lose 80-90% of the business. Also, after having recently concluded its $1 billion cost-cutting program, it will find it difficult to cut more costs to cover prescription losses.

Challenges ahead

As both parties do not appear likely to come to terms by end-year, most of the 90 million prescriptions may become available in the open market. As Express members look for a new pharmacy to serve their needs, competitors CVS Caremark and Rite Aid stand well placed to benefit.

Interestingly, the two largest Pharmacy Benefit Managers Express Scripts and Medco Health Solutions have recently been trying to merge with each other, which raises questions about the implications for Walgreen if Express Scripts gains antitrust clearance and folds in Medco next year, which could also stop doing business with Walgreen.

We value Walgreen with a revised $35 Trefis price estimate of its stock, which is at a 15% premium to the current market price. 

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