Is the Economy to Blame for Drugstore Chains' Poor Earnings?

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It's been a tough couple of years for drugstore chains. Rite Aid (NYSE: RAD) was close to bankruptcy in 2012, CVS Caremark (NYSE: CVS) recently paid $11 million to avoid civil charges due to prescription painkiller issues in its Oklahoma stores, and Walgreen (NYSE: WAG) had a battle with pharmacy benefits manager Express Scripts earlier this year. Yet, despite all of this, all three companies reported an increase in earnings in the most recent quarter.

Walgreen, likely assuming that investors would be disappointed that the results weren't better, blamed the sluggish economy. While many analysts say the economy is on the way back, drugstore chains are located in a variety of neighborhoods, including those in low-income areas. Walgreen's locations in these neighborhoods are showing slower sales, the company says.

Earnings up, shares down

Walgreen's earnings were up 16% but the fine details of the chain's earnings call brought shares down. Investors had expected a better result from the expiration of many patents that had once protected drugs like Lipitor from being made into generics. Since generics have a higher profit margin than prescriptions, shareholders expected big results from the change.

The drug retailer reported $624 million in earnings for the quarter, with a 3% increase in revenue, totaling $18.31 billion. Perhaps, the biggest concern for investors is that the sales increase was mostly isolated to the stores' pharmacies, with front-end store sales sagging. The company's CEO emphasized the company plans to focus on upping front-end sales in the next quarter through circulars and other promotions aimed at luring customers inside to shop.

Focusing on the positive

Front-end sales were also an issue in competitor CVS' earnings report. The company's net income increase of $180 million from a year earlier was largely attributed to the same generic availability Walgreen experienced. But, the good news was that CVS' front-end sales increased 1.4% year over year in the recent quarter.

CVS' expectations for the upcoming quarter wasn't quite as positive, though. The company mentioned the sequestration, leading to spending cuts that will impact Medicare spending on prescriptions for older people. CVS' Caremark division, which administers benefits for businesses and government agencies, is more closely impacted by changes to healthcare than retail chains.

Rite Aid close behind

Closing in on its competitors is Rite Aid, once the underdog of the retail drugstore business. The company follows Walgreen and CVS Pharmacy, with $91 million in earnings in its recent quarter. Last year, at the same time, Rite Aid had experienced a loss due to a charge of $21 million due to a pending litigation.

Earlier this year, Rite Aid had reason for celebration when it logged its first quarterly profit since 2007. This earnings report gave the company its second consecutive quarterly profit, giving investors increased confidence in the chain.

As all three retailers head into the second half of 2013, front-end sales will likely be a priority. Because grocery store chains, Wal-Mart, and Target all provide the opportunity to pick up prescriptions, consumers see them as a one-stop-shopping experience. What drugstores want is to capture those customers, who will hopefully buy a few extra items while picking up their prescriptions.

How can drugstores compete in this arena? Discounts. With showrooming becoming more prominent than ever, customers can easily see how the milk and bread sold in drugstores compares with the same products at their local grocery stores. Walgreen, in particular, has been experimenting with selling its own products, exclusive to its stores, such as its Delish Ice Cream.

Expectations going forward

Walgreen, CVS, and Rite Aid are heading into the summer season with cautious optimism. As they strive to increase front-end sales, will it be enough? Consumers will look at both price and convenience in choosing where to do their shopping, but if past history is any indication, Walgreen will lead and the rest will follow.

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