Wal-Mart Pressures PBM Market

Highlights include Medco Health Solutions, Inc. (MHS), Wal-Mart Stores Inc. (WMT), CVS Caremark (CVS), Walgreen (WAG), Target Corp. (TGT), Kroger Co. (KR) and Caterpillar Inc. (CAT).

Back in 2006, Wal-Mart Stores Inc. (WMT), the world's largest retailer, started first by selling select generic drugs for $4 per monthly prescription. This was a move which negatively impacted many smaller operators and pressured CVS Caremark (CVS), Walgreen Company (WAG), Target Corp. (TGT), Kroger Co. (KR) and other prescription-drug sellers into offering similar prices.

Then in September 2008, Wal-Mart entered into a direct agreement with Caterpillar Inc. (CAT) offering certain generic drugs for free as part of a pilot program for more than 70,000 Caterpillar Inc. employees, retirees and their spouses and dependents. The agreement represented a direct (prescription drug) pricing contract with the employer, and signaled Wal-Mart's entry into the PBM market. Under the agreement, Caterpillar bypasses a third-party provider and gets pricing on drugs directly from the retailer. Caterpillar then passes some of those savings on to employees by waiving a $5 co-payment on generic drugs bought at Wal-Mart.

Last week, Wal-Mart disclosed that it is currently in discussions with other firm about similar programs. Given the current economic slowdown and the increasing cost of medication, Wal-Mart's potential impact to pharmacy benefit management [PBM] industry is not insignificant.  

The largest PBM player in our universe is Medco Health Solutions, Inc. (MHS), headquartered in Franklin Lakes NJ, and a leading provider of pharmacy benefit management and Specialty Pharmacy services in the United States and Puerto Rico.

MHS recently reported better than expected 4Q08 net income of $274.4M (up 32% y/y), or EPS of $0.59, buoyed by an increase in volumes of higher margin generic scripts. We believe, the company's mail order business and allied drug management services are effectively differentiating the company from its rivals and growing market share.

Nonetheless, the entry of Wal-Mart's into the PBM arena coupled with the prospect of further industry consolidation adds to potential pricing pressure in the medium term. Our current recommendation for MHS is Hold. 

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