Walgreens Boots Alliance (WBA - Free Report) dropped over 12% today taking the price down to a low of $55, the lowest the stock has traded at since 2014. WBA’s tumble was initiated by worse than expected earnings, and a full year EPS guidance adjustment which would make them flat for 2019. Executive Vice Chairman and CEO Stefano Pessina claimed that this was the toughest quarter since Walgreens Boots Alliance’s formation in 2014. Pessina attributed the negative earnings growth this quarter to “significant reimbursement pressure, compounded by lower generic deflation, as well as continued consumer market challenges in the U.S. and UK.”
Walgreens showed a 4.6% increase in year-over-year sales for Q2 but adjusted net earnings were down 11.5%, losing $1.5 billion from the previous year. WBA EPS guidance went from 7-12% growth to flat for this year. Pharmaceutical pricing pressure from rising drug prices and steepened competition from Amazon’s (AMZN - Free Report) PillPack and CVS Health (CVS - Free Report) have pushed Walgreen’s gross margins to an all-time low of 22.3%.
The Department of Health and Human Services (HHS) made a recent proposal that could lower prescription drug costs. The HHS proposed to take away kickback protection on rebates. According to HHS Secretary Alex Azar, these rebates create enormous incentives for drug-makers to raise list prices. This proposal, which will be finalized in 2020, only includes Medicare beneficiaries but Azar is confident that commercial plans will follow suit. This proposal will take time to come to fruition and the material effects on WBA will be delayed. The proposal should help increase margins for Walgreens and other pharmacies in the future.
Retail-Drug Store Review/Outlook
The retail-drug store market has had a tough couple of years with increasing pricing pressure and a competitive landscape that’s almost oversaturated. Online pharmacies, like Amazon’s recent acquisition PillPack, are becoming a more popular choice among consumers, and are further increasing competition in this space. The deceleration in growth and deflation for generic drugs are contributing to pharmacies’ squeezed margins along with rising drug prices. Below you can see the 2-year return total return for the retail-drug stores market is -25.3%, and WBA exceeding this loss at down 30.4% in the last 24 months.
Like any struggling mature industry, consolidation is inevitable. CVS just completed its acquisition of Aetna at the end of 2018 for $78 billion funding it with cash on hand, shares of CVS common stock and $40 billion in unsecured senior notes. This was the largest merger in health care history. The merger was a vertical deal done with hopes of leveraging synergies to “have a community focus, engaging consumers with the care they need when and where they need it, will simplify a complicated system and will help people achieve better health at a lower cost”, according to CVS Health President and CEO Larry Merlo. Walgreens and Rite Aid were going to merge back in 2017. Instead, Walgreens agreed to buy about half of Rite Aid’s stores (2,186) for $5.2 billion. These mergers are likely to continue as economies to scale become more evident. WBA – Zacks Rank #4 (Sell); CVS – Zacks Rank #4 (Sell).
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