The return of Express Scripts prescriptions and growth in generic prescription drugs dispensed saw the largest drugstore chain in the U.S. Walgreen (NYSE:WAG) post a growth in profits in the quarter ending February. Fiscal 2013 second quarter net earnings were $756 million compared with net earnings of $683 million in the year ago quarter. Revenues from the quarter were flat at $18.6 billion. The strong performance saw the company’s stock price rise by 5.4% in a day.
Walgreen along with Alliance Boots GmbH, announced a 10-year distribution agreement with AmerisourceBergen beginning September 1. The former have also been granted rights to buy up to a 23% stake in the latter. AmerisourceBergen is a pharmacy services provider and will distribute branded pharmaceutical products that Walgreen has historically distributed and it will help Walgreen source and distribute generic drugs internationally potentially bringing both growth and better purchasing power with drug manufacturers. Beginning in calendar year 2014, this will increasingly include generic pharmaceutical products that Walgreen has so far self-distributed.
Prescription sales account for 60% of the company’s sales and were flat in the quarter. However, prescription sales in comparable stores decreased about 3%. The company filled 208 million prescriptions in the quarter, an increase of 6% over last year’s second quarter. The growth was a result of the return of Express Scripts prescriptions after the two company ended its dispute effective last September. The growth in prescriptions filled also helped mitigate the negative impact of more generic prescription drugs being dispensed.
As the new arrangement with Express Scripts has been in force for almost six months now, we expect the growth in prescriptions filled to decelerate over the coming months. Also, the generic penetration is expected to keep growing in the near term as blockbusters drugs with $170 billion in annual sales will lose patent between 2012 and 2015. ((Cliffhanger, The Economist, December 2011)) We expect the combined effect of these to keep sales from prescriptions drugs under pressure in the near term.
Decline In Front End Sales Could Be A Worry
Walgreen has been gradually rolling out a new store format across the country, which stocks a wide variety of groceries and includes café, juice and smoothie bars. Despite its efforts, customer traffic in comparable stores decreased 5%, even as basket size increased 3%. As a result, front-end comparable store sales decreased 3% in the second quarter. As the new format stores are still few in number, their impact will be visible in the coming quarters. We believe that the new formats which stock several high margin items under beauty, personal care and convenience, and fresh food categories will also help drive traffic and sales growth. Our expectations are in line with the trend in 2012, when Walgreen stated that the increase in fiscal 2012 comparable front-end sales was primarily due to beer and wine, non-prescription drugs, beauty and photofinishing categories, and was partially offset by decreased sales in household products. We will watch for how front-end sales play out in the coming months.
AmerisourceBergen Agreement Will Provide Support To Margin Growth From Generic Penetration
Walgreen along with Alliance Boots GmbH announced a long-term partnership with pharmaceutical services firm AmerisourceBergen during the earnings call. The two companies agreed to expand their existing relationship to a 10-year comprehensive primary distribution agreement for branded and generic pharmaceutical products. Currently, Walgreen distributes more than 80% of its own drugs, but over time most if not all of that distribution will be handled by AmerisourceBergen. Currently, AmerisourceBergen distributes some specialty items.
We expect that by combining its distribution in the United States and Europe with AmerisourceBergen, Walgreen will be able to negotiate better prices for those bulk drugs. This should help margins over time.
We have a revised $42 Trefis price estimate for Walgreen, which is 5% below the market price.
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