Investing In Pharmacy Stocks Could Be The Next Major Play

 |  Includes: APHYQ, BIOS, CVS, RAD, WBA
by: Stock Investor

The full implementation of the Patient Protection and Affordable Care Act (PPACA), commonly referred to as Obamacare, is only a few months away. On January 1, 2014, all aspects of the healthcare overhaul will begin. As an investor I started to look for potential opportunities on how to play this major government program. The expansion of the program will inevitably lead to an increased use and need for pharmaceuticals. Those who previously were uninsured will be able to seek medical attention and much needed prescription drugs. The demand and need for more prescription drugs will benefit not only the drug companies, but those that deliver it, pharmacy companies. With accountability a major concern for those against Obamacare and the crackdown by both the FDA and by doctors in the prescribing of drugs over the last year, especially pain drugs, I began thinking about a possible angle for investors to consider when it comes to the management of drugs. I began to look into the drug store sector to see if there was a possible investment angle. This sector has done very well so far this year and it appears poised to continue this advance into next year and beyond.

Walgreen Co. (WAG) is up close to 30% so far this year, a tremendous return for such a large cap, boring company. With $70B in sales it is the second biggest drug store in the U.S. WAG is making a big push to benefit from Obamacare with in-house clinics. Take Care Clinic as it is called, is a healthcare service that includes diagnosing and treating patients for chronic conditions such as asthma, diabetes and high cholesterol. Using this model WAG hopes to garner some of the monies that will flow into healthcare under Obamacare. Earnings in the most recent quarter were flat year over year. The company did generate $1.2b in positive cash flow. WAG also pays a $1.10 in dividends per year for an annual dividend yield of 2.2%. This is attractive for investors. With growth flat year over year the stock may be poised for gains in the next couple of years thanks to the expected market expansion due to Obamacare and this makes the stock a definite candidate for investment.

Last year WAG acquired certain assets of BioScrip's (NASDAQ:BIOS) community specialty pharmacies and centralized specialty and mail service pharmacy businesses for approximately $225 million. WAG did this to bring additional specialty pharmacy products and services closer to patients. This still leaves BIOS as a player in the specialty pharmacy market, one of the few publicly traded ones that are left. I was actually surprised at how few there are remaining, a sign for investors that now is the time to consider strongly moving into the sector. Since January BIOS has seen its share price gain close to 40%. With a forward PE of 32, however, the stock is not cheap when compared to the multiples seen in its peers. However, for those investors not wanting to invest in the likes of WAG, RAD and CVS, there are few choices left. In December BIOS spent $70m to acquire HomeChoice Partners, a leading provider of alternate-site infusion pharmacy services. HomeChoice generates approximately $70 million in annual revenue, servicing approximately 15,000 patients annually. This specialty pharmacy should be a big beneficiary of the expansion of healthcare in the U.S. By partnering with patients, physicians, healthcare payors, government agencies and pharmaceutical manufacturers BIOS is now able to provide access to infusible medications and management solutions. With the FDA and DEA looking to limit the availability and abuse of pain medications, this could be a very attractive niche segment under Obamacare.

Investors should take note that short interest in BIOS dropped 22% for the most recent month, a possible sign that investor interest is about to surge in the stock. Bearish positions in BIOS may be expecting a surge in revenues for the stock into the 2014 Obamacare rollout. The most recent earnings report for BIOS showed a 27% increase in revenues. Infusion services, an area that is sure to grow in the coming years under Obamacare, posted an impressive 41% growth rate. Growth rates such as this for a midcap company are something an investor such as myself looks for when seeking investment in a sector. BIOS expects to post $850m in revenues in 2013. With Obamacare those revenues should increase to over $1b. There is of course risk that investors should be aware of with BIOS. The company announced it has zero cash as of the most recent quarter. With the stock up 40% this year it would be prudent for BIOS to consider some dilutive financing to fund future growth. This risk of near-term dilution is high given the zero cash balance. However, for investors looking to enter this stock, a decrease in the stock price due to financing would be very welcome. BIOS is a very attractive play on Obamacare in the specialty pharmacy segment I am looking to focus on. Any investment here right now should be done with the expectation of adding on a drop in price.

Rite Aid Corporation (NYSE:RAD) has seen its stock price gain over 150% since the start of the year. Part turnaround story, part play on Obamacare, there is no arguing that investors in the sector have reaped some nice returns this year. In the most recent earnings report, RAD reported its first profitable quarter in many years. RAD posted net income of 13c per share compared to an 18c per share loss. This gain came despite a drop of 9.7% in revenues. RAD has not been without its problems over the last few years. Over-expansion and a heavy debt load of $6 billion has taken its toll. As we drive closer and closer to the full implementation of Obamacare though, this sector is enjoying increased investor enthusiasm. The ability of RAD management to deliver profits despite lower revenues is a strong sign to investors that the stock is worth watching, especially with increased revenue under Obamacare a distinct possibility. Also, the ability for these profits when revenues are decreasing are a sure sign that the current management is serious about profitability. When companies have underperformed for many years, as RAD has, they tend to fall off the radar of investors. When these stocks start to turnaround, as RAD appears to be doing, there can be outsized gains in the early stages for investors willing to accept some risk. However, RAD is behind both WAG and CVS when it comes to in-house clinics. So far only 58 of its pharmacies in the Baltimore, Boston, Philadelphia and Pittsburgh area are using the Internet to allow customers to talk to doctors and nurses at remote locations. RAD is so far lagging the other retail pharmacies in growing to meet the increased monies from Obamacare. If RAD is able to show continued upside momentum in the coming quarters, it would move to the top of my list of investment ideas in this sector. Management has delivered a profitable quarter. If RAD can continue this trend into year-end, it could be well positioned to be a big winner under Obamacare. Also, with the stock up so much this year I question the merit of chasing it up this high, so, for now, I need to look further. A retrace in the stock price in the coming weeks would, however, make me willing to consider an investment here. For this reason investors should keep a very close eye on the stock.

CVS Caremark Corporation (NYSE:CVS), the largest drug store chain, is up a smaller 20% so far this year, but this too is an outsized gain for a sector that is typically slow moving. Again, a large part of the reason I believe these stocks are up so much is a movement into sectors and stocks that will benefit from the rollout of Obamacare. Both WAG and CVS are interesting plays in the sector, but for now these stocks are best watched for a retrace for entry. CVS reported better than expected earnings last week. A 29.9% increase in EPS to 77c and $1.3 billion in positive cash flow were the big positives from the report. The annual 90c dividend, which equates to a 1.55% dividend yield, is also an attractive component to investing in the sector and this stock. CVS's is also rolling out its own in-store clinics, called MinuteClinic, to grab some of the monies from Obamacare. This segment increased same-store sales by more than 38 percent in the fourth quarter. As investments both CVS and WAG are two excellent ways to play the expected market increase from Obamacare. Even before the full rollout of Obamacare, CVS is generating close to $6b in annual positive cash flow. As an investor looking to benefit from Obamacare, this cash flow, and decent dividend, definitely warrant a closer look and potential investment. Despite its large size, CVS has been able to deliver solid EPS growth in the previous quarter. When compared to some of the high beta tech stocks, the growth rate seen last quarter in this "old-school" stock is impressive. With the large advance in CVS so far this year, and despite the impressive growth rates before the full Obamacare rollout, I feel it is a stock to watch very closely for an investment on retrace in price. Therefore, I decided my focus needed to be on smaller, specialty pharmacies. To my surprise this was actually a hard feat. Expansion in the sector by the large retailers over the last few years has seen many of the smaller specialty pharmacies gobbled up. The large chains continue to look for opportunities to grow their business, but potential take-over's are becoming fewer and fewer.

Assured Pharmacy, Inc. (APHY.OB) operates pharmacies that provide prescription pain medications for chronic pain management. It primarily sells prescription drugs. The company's business model targets physicians specializing in pain management - orthopedics, neurology, oncology, psychiatry, physical rehabilitation, and industrial medicine. The niche that APHY focuses on is one in which the company only serves the doctors. It does not accept walk-in customers like traditionally retail pharmacies. This is a niche business that could grow very well in the coming year. With a greater expansion of healthcare under Obamacare the market for pain prescriptions is likely to grow, and this could be a big benefit to specialist pharmacies such as APHY. When I was looking at this sector initially, what jumped out at me was the growth plans from the company. Not only are there plans to add six additional stores, the company has also stated that it plans to seek a listing on one of the main exchanges, another positive for investors. APHY is what I would view as the speculative component of an overall investment in the sector. The large cap portion of an investment in specialty pharmacy is one thing, but for a risk component APHY looks very interesting.

The risk to APHY is also a benefit. APHY counts the major prescription chains, such as RAD and CVS, as competitors. Consumers are able to have their prescriptions filled at these retail pharmacies, but typical retail pharmacies either do not keep in inventory or keep limited amounts of Class II pain drugs. Increased regulation of pain drugs and Class II drugs is slowly forcing these retail chains to pull back from this market. As a result, the time it takes for traditional retail pharmacies to fill a prescription for Class II drugs is extended. Because of its pain management focus, APHY maintains an inventory of these Class II drugs at all times. The ability to fill these pain prescriptions quickly is a distinct advantage over the large retail pharmacies. Also, with the direct relationship APHY has with doctors, there is an opportunity for increased profits on the doctors' end, which in turn helps solidify their relationship with APHY.

From January 1, 2013 through March 15, 2013 APHY raised $660,000 in financing, but with new store openings planned there will be a need for additional financing, something investors must consider. In February 2013, the company also entered into a secured loan agreement with their primary wholesaler. Under the terms of this agreement, the company received a one-year loan of $3,828,527 with an interest rate of 6.25% per annum. For the most recent year APHY posted revenue of $14.1M, a decrease from the previous year. The decrease has been attributed to more generic pain medications hitting the market.

The one big negative with APHY is of course the fact it is a microcap stock. The low volume, low market cap makes this a high risk component of a play in the sector. However, by using the basket approach of investing I have talked about in previous articles, such as "Speculative Bio Stocks For Investors", there is room for high risk plays such as APHY. Investments in stocks such as this should be considered smaller than those in more established stocks such as CVS, RAD, BIOS and WAG. Also, the fact that there are so few stocks left in the specialty pharmacy area due to large retail pharmacy buyouts, is a testament to the high potential return in the remaining public companies. With so few other public companies left, stocks such as APHY and BIOS should attract strong investor attention.

As we move closer and closer to the implementation of Obamacare in 2014 there will be a greater interest for investors to get involved. The time to do that may be now. The large pharmacies have seen very nice upside moves this year. Investors, with some risk appetite, may be well rewarded looking to the niche specialty pharmacy sector for investment potential.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.