3 Risks This Pharmacy Retailer Should Worry About

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Every equity investment comes with its own set of risks. Evaluating those risks is an important step in determining the worthiness of a potential investment. Looking at pharmacy retailer Walgreen’s (NYSE: WAG)  2012 form 10K three risks stand out as especially relevant in determining Walgreen’s future as an investment.

The first risk conjures up thoughts of Walgreen’s impasse with Express Scripts (NASDAQ: ESRX), “We derive a significant portion of our sales from prescription drug sales reimbursed by pharmacy benefit management companies.”

People retain long memories of soured relationships even if some of the fences get mended. In business, people approach individuals with caution when they have had conflict in the past. For example, Walgreen and Express Scripts parted ways for eight months in 2012. In the Form 10K Walgreen discussed the reluctance of some insurance carriers to come back; “the United States Department of Defense TRICARE program, an Express Scripts client, announced that Walgreens would continue to be designated as a non-network pharmacy provider for TRICARE beneficiaries.”  My wife’s personal insurance carrier also refuses to go back to Walgreen due to uncertainty around what happened between Walgreen and Express Scripts.

Walgreen’s report on December sales shows a decrease of 4% indicating continued tailspin from the impasse discussed above. Comparable sales decreased 6% versus this time in 2011.

In contrast, Walgreen’s loss translates into gains for competitors such as CVS (NYSE: CVS).  CVS revenue gained 13% in its most recent quarter. In addition, CVS expects to retain 60% of prescription business. Walgreen’s sour taste will take a while to fade and shareholders will suffer in the meantime.

The second risk to Walgreen relates to the consolidation of purchasing power in the industry, “Consolidation in the healthcare industry could adversely affect our business, financial condition and results of operations.” CVS acquired pharmacy benefit manager Caremark and now ranks No. 2 in the pharmacy benefit management market.  CVS estimates that it ranks No. 1 in prescriptions filled annually at 990 million. Walgreen rests in the No. 2 spot with 785 million. The drive for lower medical costs will serve as catalyst for future consolidation. If Walgreen doesn’t execute well on this front it could spell disaster for its shareholders. This leads to the third highlighted risk…..

Our growth strategy is partially dependent upon acquisitions, joint ventures and other strategic investments, some of which may not prove to be successful.”  In the early part of 2012 Walgreen acquired Bioscrip as part of the initiative to expand its involvement with specialized and mail order pharmacy.  Bioscrip also performs home health care and other services not related to pharmacy.  This acquisition deviates from Walgreen’s core competency of Pharmacy.

In 2012, Walgreen also stayed true to its core competency with some of its acquisitions. Walgreen purchased privately held drugstore chains such as USA Drug and websites such as drugstore.com and broke ground abroad with an investment in international health and beauty group Alliance Boots serving mainly Europe and the former Soviet Union with limited presence in Asia and northern Africa.

Walgreen’s international investment could face trouble due to the volatile euro and political uncertainties surrounding sovereign debt in countries such as Greece.

On the whole, Walgreen needs to work hard on staying in Express Scripts’ good graces. This doesn’t mean other stakeholders such as insurance carriers will return. In addition, Walgreen will need to stay on top of the consolidation trends to compete effectively on pricing and stay within its core competency with its acquisition strategy, otherwise they may face write downs in the future. In any event, Walgreen is a company for investors to avoid.

stockdissector has no position in any stocks mentioned. The Motley Fool recommends Express Scripts. The Motley Fool owns shares of Express Scripts. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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