The Affordable Care Act Will Drive Retail Pharmacies To Higher Profits

Includes: ABC, CVS, ESRX, RAD, WBA
by: Henry Kawabe

It's been a good year for the three major retail pharmacy chains: YTD CVS Caremark (NYSE:CVS) is up 31%, Walgreen Co. (WAG) is up 61%, and Rite Aid (NYSE:RAD) has soared 286%. With more generic drugs coming to market and the Affordable Care Act (ACA) less than two months away, retail pharmacy chains are gearing up to welcome what is expected to be an onslaught of newly insured Americans. With the changes in healthcare, pharmacy chains are expanding their reach to become a one-stop healthcare shop for not just prescriptions, but for other medical needs such as flu shots and minor injuries. Soon these retail pharmacies will further encroach on an area where physicians once had the monopoly: managing chronic diseases such as diabetes and asthma. This strategy should add to more revenue for the pharmacy chains with both CVS and Walgreen leading the way.

Adam J. Fein, a healthcare industry consultant who runs the Drug Channels blog, sees changes coming to the way people are currently treated. "Retail competition is coming to healthcare, and pharmacies are on the leading edge." According to the Congressional Budget Office, healthcare spending in America will balloon to 22% of gross domestic product in 2038, from 16.4% in 2011. That means that healthcare spending will account for more than a fifth of the economy, and retail pharmacies are looking for a larger piece of the pie as they move beyond filling prescriptions.

ACA -- Making Pharmacies A One Stop Shop

The government's ACA will bring in approximately 30 million newly insured customers into the healthcare system. Walgreen, CVS, and Rite aid recognize that the millions of people who stand to gain health insurance represent an opportunity for increased pharmacy business in all aspects of the store from drugs to personal products to acute medical needs. To insure a share of the new found customer base, the pharmacy companies have been working closely with the government in promoting uninsured customers to sign up for health insurance with the goal of having them visit the pharmacy clinic and load their baskets with front end merchandise.

Helena Foulkes, executive vice president and chief health care strategy and marketing officer for CVS, said in an email to Pharmacy Times: "Seventy-five percent of Americans live within 3 miles of a CVS pharmacy, and we serve 5 million people each day in our stores. That gives us a tremendous opportunity to help Americans understand the new health care law and how it affects them so they receive the coverage that best fits their families."

Walgreens President and CEO, Greg Wasson, discussed new opportunities for the chain to participate in the nation's health system, pointing out that doctors' offices will be overwhelmed with the new clientele. "With nearly 70 percent of the U.S. population either without a primary care physician or not utilizing one, and more than 30 million people gaining insurance coverage in 2014 under health care reform, we are well-positioned to fill the void in care."

Walgreen already operates 370 in-store clinics called Take Care clinics in 18 states, and more than 350 health and wellness centers on the campuses of large employers. Take Care clinics are staffed with nurse practitioners and physician assistants who can diagnose conditions and also write prescriptions, plus refer patients for additional tests if needed, and will lead in managing their conditions. While Take Care clinics focus on flu shots and acute care, Walgreen plans to add chronic care to its services, managing such chronic diseases as asthma, diabetes, and high cholesterol. Managing patient's chronic care could prove very profitable as chronic illnesses account for roughly 75% of the money spent on health care.

CVS is also gearing up with its in-store Minute Clinics, which have already generated over 17 million visits. Currently the company has 684 minute clinics, but plans to more than double the number by 2017, with a long-term goal to develop a primary care platform across the country. To date, the clinics in the retail pharmacies have not been a profit driver for either company, but analysts expect that to change when the newly insured need medical attention quickly and the doctors' offices are filled. Les Funtleyder, investment strategist with Poliwogg, commented, "When a number of people come into the system, it tends to stress the provider networks, meaning there are only a finite number of primary care physicians to care for all these people." Mr. Funtleyder also sees these pharmacy clinics will be most attractive for those who enroll in lower-cost health insurance plans. The lower-cost plans have higher deductibles and pharmacy clinics charge roughly 60% less than a doctor's office visit.

Rite Aid has taken a different approach with its in-store clinics dubbed NowClinic. NowClinic is an online care provider offering real-time access to nurses and physicians on the Internet, allowing patients to speak with health care professionals using secure live chats and webcams. According to Rite Aid, NowClinic is similar to an office visit in that the doctors review health concerns and symptoms, discuss medications, and have access to other healthcare facilities for further treatment when necessary.

Generics -- Lower Revenue, Higher Profit Margins

A major benefit of the government's ACA is making prescription drugs accessible and affordable to the masses, mostly in the form of generics. Between 2004 and 2010, generic drugs eroded the market share of branded drugs at an average rate of 7.6%, and by 2010 71.2% of the prescriptions filled were generic drugs. In 2012, 40 name brand drugs that brought in $35 billion came off patent, while in 2013, 14 name brand drugs generating sales of $17 billion lost patent privileges. In 2014, 18 drugs will come off patent, while in 2015 only 9 drugs will lose patent privileges. While new generic drugs coming to market will decline, generic drug sales should continue to rise as prescription drugs are considered an essential health benefit under Section 1302 of the ACA, and most health insurance plans encourage or in some cases mandate the use of generics. While the actual drug makers may not see as much profit as hoped due to new tax laws, retail pharmacies should reap the benefits in higher sales and profit margins. While name brand drugs bring in as much as 300% more in revenue than generic brands, generics carry a higher profit margin. Also, with the wave of new clients expected in 2014, CVS, Walgreen, and Rite Aid should see higher earnings per share (EPS).

The proof is already evident: CVS saw third-quarter earnings climb 25% as generic drugs and improving pharmacy benefits and health management business helped beat Wall Street expectations. More than 81% of the prescriptions CVS dispenses from its retail pharmacies are now generics. In the same quarter 2010, CVS had a 73% generic dispensing rate. The company also raised its 2013 earnings forecast from $3.90 to $3.96 adjusted EPS, to $3.98 to $4.01 adjusted EPS.

Walgreen saw a 0.7% negative impact comparable store sales in the last 12 months due to its now fixed dispute with Express Scripts (NASDAQ:ESRX) and its rising generic sales. Generic drug sales climbed to 78.5% in 2012, from 74.1% and 71.5% in 2011 and 2010. The company closed its fiscal 2013 on August 31st with $72.2 billion in sales, a 0.8% annual increase. But like CVS, due to the higher profit margins with generics, the company had a 13.7% increase in operating income.

CVS is $77 billion market cap company with 7,601 retail drugstores. The stock closed on Monday, November 11th at $63.93, just below its 52-week high. The stock has a P/E of 17, and has a yield of 1.41 per share. On November 6th, both analysts at BMO Capital Markets and Raymond James separately raised its target price from $66.00 and $65.00, to $70.00, each giving CVS an "outperform" rating. On the same day, analysts at FBR Capital Markets were even more optimistic raising their price target from $69.00 to $72.00.

Walgreen is a $56.2 billion market cap company with 8,177 drug stores throughout the country. The stock closed on Monday, November 11th at $59.45 per share, just shy of its 52-week high. The stock has a P/E ratio of 23.19 and a yield of 2.12 per share. Last year the company purchased 45% of the giant British pharmacy-- Alliance Boots-- for $6.7 billion, with an option to buy the remaining 55%, making it the world's largest retail pharmacy chain. The company also struck a 10-year deal with AmerisourceBergen (NYSE:ABC), the $56 billion pharmaceutical services company. The deal makes AmerisourceBergen the primary supplier of brand name pharmaceuticals to all Walgreens locations and, in the future, the primary distributor of all generic products.

On November 8th, Walgreen completed its acquisition of the 76-drugstore chain, Kerr Drugs, based out of Raleigh, NC. Kerr has been on the forefront of transforming its pharmacies into health care providers, and Walgreen hopes to expand its presence in the reign. Walgreen acquired Kerr Drug's retail drugstores, specialty pharmacy business, and a distribution center, while Kerr Drug retained ownership of its long-term care pharmacy business.

Also, in late September, Walgreen announced a long-term partnership bringing the Palo Alto based Theranos, along with it's new lab testing service, to Walgreens pharmacies nationwide. Soon consumers will be able to access less invasive and more affordable clinician-directed lab testing from a blood sample as small as a few drops, or 1/1,000 the size of a typical blood draw. Theranos developed its tests for the masses to be low cost and 50% of Medicare reimbursement rates or less. Results of such tests are available in a matter of hours, enabling fast diagnoses to help with informed treatment choices.


I think the future looks bright for the retail pharmacy chains. Given the impending ACA and the higher income on generic drugs, the retail pharmacy sector is a good place for investors with a long-term view. The ACA will bring millions of people through the front doors of retail pharmacies. And I believe that due to the ACA, pharmacies will change the way people view healthcare and these stores will become a one-stop shop for many of the newly insured. While the ACA will affect all aspects of healthcare and companies involved in the sector, my two choices are Walgreen and CVS. While Rite Aid has worked hard to straighten out its messes and its stock has risen significantly in the last year, I see the company lagging behind the other two when it comes to a long-term investment.

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. I have no business relationship with any company whose stock is mentioned in this article.