Wal-Mart's Generic Drug Plan: Macro Implications

Wal-Mart (WMT) announced on Thursday, September 21st that it will start selling nearly 300 generic drugs at greatly reduced prices. The announcement was "pooh-poohed" by the usual industry analysts. Yes, it is not 300 drugs and only 90 drugs with different doses. Yes, it is only in Florida. Yes, it doesn’t do anything for Wal-Mart’s employee healthcare coverage, or is that "non-coverage." Yes, it is being flaunted as a PR program claiming to help 2.7 million uninsured Floridians. Everyone seems to be missing the point!

Background

The two most potent ingredients contributing to inflation woes that are threatening the health of the U.S. economy are energy and healthcare. The third ingredient is the Federal deficit. Energy seems to be getting under control so now it is time to tackle healthcare. Coincidently Mr. Economy has a willing ally. Wal-Mart doesn’t want the politicians to mess with their empire so it makes sense to play ball and make a buck at the same time.

The bigger picture reveals a paradox. In order for the stock market to flourish, businesses have to show a YOY (year over year) increase in both revenues and profits. If businesses continue to expand as they have done for another year, this in turn will put pressure on the Federal Reserve, due to inflationary price pressures, to increase the interest rate in order to slow down the economic expansion. If the Fed increases the interest rate, then the rate of growth is limited. If the rate of growth is limited, then the Federal deficit increases as the mechanism in place relies on growth as the only means to reduce the deficit. If the deficit grows… and so on.

The objective is to transform the negative chain reaction into a positive one. Just to get you started, this means: increase economic activity by increasing the amount of services and goods purchased without printing more money to put into the hands of the public. In other words, reduce costs of the imported components in the U.S. economy. The more times a dollar bill changes hands, the higher the economic activity and this means higher tax receipts, but we won’t get into that now.

Three Strikes and Inflation Is Out

When it came to the energy component, the solution was obvious. Since the majority of energy is imported, lower raw material costs meaning lower crude prices have a positive impact on the economy. Imports are lower yet the U.S. component in the production chain is not dramatically changed. The consumer spends a smaller percentage of his/her income on energy, leaving more dollars for other expenditures and maybe some savings.

Healthcare is a whole different ballgame. The vast majority of healthcare costs are local U.S. inputs. Both personnel and the majority of equipment are “made in USA”. Any price reduction, (i.e. lower salaries or lower equipment prices) would have a direct adverse effect on the economy.

The only area that can take a hit without adversely affecting the economy is the generic drug scene. Teva (TEVA) probably saw this coming. As the largest seller of generics in the United States, margins are going to be pinched by Wal-Mart playing on its home turf, and Florida is the test market. As usual, Wal-Mart lobs an idea into one location, refines the strategy, steals some base suppliers from the competition (probably to include every generic drug under the sun) and with bases loaded, goes national. It will be interesting to see Teva’s game plan. How the battered Federal deficit is going to play out is beyond me.

By the way, one of us played baseball yesterday.

Disclosure: This article was written by a CrossProfit analyst and may not reflect the opinion of CrossProfit.com. Unless explicitly stated otherwise there are no conflicts of interest.

Comment on this Article

Comments

[AlB:]

Hi - I think you should remove your Walmart-hate before writing. There are two interesting facts concerning generic pricing and Walmart's "predatory" pricing. First, Costco already sells at least one of the generics in question for $3.69!! Second, CVS sells a number of these same generics for $10.99. Now you tell me - who is screwing those Florida seniors, Walmart or CVS??? Further, if Costco earns money at $3.69, just how much is CVS making??
I don't particularly like Walmart. However, why does everyone go after them and no one ever looks at CVS, its pricing, its employee benefits, etc. Also, check out how much of their profit comes from prescription drugs

2006 Sep 25 09:33 AM

[CrossProfit:]

Robert Daniel’s MarketWatch article appeared on Yahoo! Finance immediately after the Seeking Alpha article above.

www.marketwatch.com/Ne...;siteid=mktw&g...

Ouch!!! Perhaps the article wasn’t clear enough.

Daniel wrote “Last week, the shares (TEVA) had slumped when Wal-Mart Stores said it would test a program to slash the prices on a number of generic drugs. Analysts said over the weekend that the sell-off in Teva was "a bit of an overreaction," said Saar Golan at Leader & Co. Investment House. Teva sells some $11 million of products to Wal-Mart.”

The whole point of the article is that everyone is missing the obvious. It is not about Wal-Mart. It is not about “how much and who” sells to Wal-Mart. It is about America doing something about lowering healthcare costs. Wal-Mart is just a medium through which drugs are going to get cheaper for EVERYONE. Wal-Mart may be transforming into a modern day Robin Hood - or not. It doesn’t make a difference; the point is that they fired the first shot.

All drug retailers are going to have to compete sooner or later. When that happens the pressure is going to be on the distributor (like Cardinal Health – CAH) who is going to put the pressure on the manufacturer/supplier.

It is not about private versus insured either. Do you really think that in comparison with the private sector, insurers will be willing to pay higher prices to the drug companies? This has happened in the past so many times in so many industries that we find it mind boggling that the obvious is being overlooked. The first step towards a macro change has been taken.

2006 Sep 26 08:25 AM