Really Walgreen? Really?

By Chad Henage - September 19, 2012 | Tickers: CVS, ESRX, WAG | 0 Comments

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Unfortunately there isn't a nice way to say this, Walgreen (NYSE: WAG) is up to their old tricks again. Apparently some issue with pricing has caused Tricare (a military insurance plan) to decide that Walgreen will not be part of their prescription network. If you are saying, but I thought we were past all this with Express Scripts (NASDAQ: ESRX) all I can say is so did I. Most people know that Walgreen and Express Scripts had a battle over pricing that left millions of customers unable to use Walgreen as their pharmacy of choice. Though the issue with Tricare is a smaller segment of customers, it is an issue because it belies an underlying issue. Apparently Walgreen management doesn't have a grasp of the concept that some business is better than no business. 

What Happened with Express Scripts?

Walgreen management I'm sure had to eat some crow when they realized their results were being crushed by the loss of their Express Scripts relationship. I've written about this before, prior to Walgreen losing the Express Scripts agreement, their same-store pharmacy sales increased 5.3% in the 4^th quarter of 2011. After this agreement expired, the company's same-store sales declined by at least 6% for the next several months in a row. Solving this issue with Express Scripts was a huge win for Walgreen investors, and in theory the company could concentrate on winning back all of the customers they lost over the last nine months. Well, here we go again with Tricare.

And...Here We Go Again:

Long story short, Tricare is one of Express Scripts largest customers. This network of 6 million members decided that the cost to have Walgreen as part of their network was too high. While their members can in theory fill their prescriptions at Walgreen, pay full price and then be reimbursed later, that won't happen. Most people with insurance never see the real price of prescriptions. Telling a military family that they have to pay $125 for a prescription, so they can get reimbursed for $100 of that just isn't going to fly. The fact that Tricare is managed by Express Scripts means that these 6 million members haven't been able to use Walgreen anyway, but this just makes it even more difficult for Walgreen to try and win back these lost customers. Pharmacies just need to accept that this is a fact of life going forward. It is to Express Scripts benefit to convince their members to choose smaller, cheaper pharmacies that will fill prescriptions at the lowest cost. If Wagreen management doesn't see the writing on the wall, they need to wake up. Considering that Walgreen's new agreement with Express Scripts just started on September 15 and they are already offering a $25 Walgreen card if you transfer prescriptions, they now have about 6 million people who won't realistically consider this option.

Who Wins and Who Loses?

The winners in this scenario are all the other pharmacies aside from Walgreen that these members can still go to. The primary beneficiary should be CVS Caremark (NYSE: CVS). With thousands of stores and good name recognition in the pharmacy business, CVS will gladly allow Walgreen to stumble all over themselves to not win customers away. In effect, unless this issue with Tricare is resolved there are 6 million customers that CVS doesn't have to worry about losing to Walgreen. I've been impressed with the CVS operation and with this development I expect their outperformance to continue.

While Walgreen is struggling with comparisons to last year and trying to win back customers, CVS just keeps turning in impressive results. CVS has their own pharmacy benefit management division that grew revenue by 28.2% and processed 14% more claims in their most recent quarter. With CVS pharmacy same-store sales up 7.2% you can see they are gaining customers from Walgreen's missteps. Two of the most impressive statistics about CVS is the fact that they are only paying out about 13% of their free cash flow in dividends, and they are growing the dividend by nearly 30% in recent years. I would also expect retailers like Target and Wal-Mart to benefit as well as each company has been trying to make their pharmacy operations more visible. Both of these big box retailers are also visited on a very regular basis. The convenience of doing your grocery shopping while waiting for a prescription to be filled, is an attractive option for many families. Since Walgreen expects adverse effects from the loss of these Express Scripts, customers into the 3^rd and 4^th quarter of the year, they stand to be the clear losers. The company already expected tough comparisons before this Tricare issue, and I can't imagine this makes things any easier.

Conclusion:

When I heard Walgreen patched up their relationship with Express Scripts, I wrote that with 10% EPS growth and an over 3% dividend, the stock once again looks attractive. However, this recent issue causes me to rethink that position. I'm sorry if this seems judgmental, but Walgreen is coming off as greedy. The larger issue with Express Scripts and now with Tricare makes it seem like Walgreen is drawing a line in the sand and daring companies to cross it. There is one big problem, Express Scripts and their customers don't need Walgreen as much as Walgreen needs their business. I've said it before, but I'll say it one more time. Walgreen management listen carefully, when you draw that line in the sand on pricing, just remember that if they walk, you make nothing. Walgreen investors, I'm sorry I don't know what to say. I read the headline about Tricare and all I could think was...really Walgreen? Really?

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