Walgreen Co. (NYSE: WAG), d/b/a Walgreens (without an apostrophe), is the largest drugstore chain in the United States.[4] The company operates 7,600 drugstores across all 50 states, the District of Columbia and Puerto Rico. Walgreens provides access to consumer goods and services and pharmacy, health and wellness services in America through its retail drugstores, Walgreens Health Services division and Walgreens Health and Wellness division. Walgreens Health Services offers pharmacy patients and prescription drug and medical plans through Walgreens Health Initiatives Inc. (a pharmacy benefit manager), Walgreens Mail Service Inc., Walgreens Home Care Inc., Walgreens Specialty Pharmacy LLC and SeniorMed LLC (a pharmacy provider to long-term care facilities). Walgreens Health and Wellness division includes Take Care Health Systems. Walgreens has 7,600 drugstores as of September 30, 2010.[5] Walgreens was founded in Chicago, Illinois in 1901, and has since expanded throughout the United States. Its headquarters is located in the nearby suburb of Deerfield, Illinois.


Walgreens (NYSE:WAG) is a U.S. drug retailer that sells both prescription and non-prescription drugs as well as retail merchandise (cosmetics, convenience foods, photo processing services, seasonal merchandise, etc). In addition to its store offerings, Walgreens provides pharmacy services like prescription fulfillment. The company operated 6,997 retail locations in the U.S. in 2009, a 8.6% increase from 2008;[1] however, the company has stated that they will slow the pace of new store openings to 3% by 2011.[2] The company reported net sales of $63.3 billion and net income of $2 billion in 2009, a 7.3% increase and 7% decrease respectively.[3]

The company did not perform well during the recession as higher operating costs negatively affected the company's bottom line -- explaining the 7% decline in net income. However, during the downturn, the company did have positive sales growth -- in 2009, net sales increased 7.3% -- indicating that the demand for prescription drugs, the company's main product, was not hurt by the economic forces.

Several obstacles to growth exist for Walgreens as it continues to battle with the growing CVS Caremark Corporation (CVS). In the summer of 2010, Walgreens decided to drop itself from CVS' retail pharmacy network - a network of pharmacies that allow consumers to buy prescription drugs for reduced prices and then later be reimbursed by CVS - because it did not believe that it was getting a fair share of the profits. In 2009, the network accounted for 7% of Walgreen's revenue, something that the company has to make up looking forward. Walgreens does have the luxury that in 2009 it Walgreens made 20% of all pharmacy transactions and owns more than 50% of the 24-hour/drive-through pharmacies in the US.[4]

Contents
1 Company Overview
1.1 Product Classes[6]
1.2 Acquisition of Duane Reade
2 Financial and Operating Metrics
2.1 FY2011 Q1 Earnings Summary
3 Trends and Forces
3.1 Tension Between CVS Caremark and Walgreen Over Retail Pharmacy Network
3.2 Economic Slowdown Hurts Walgreens
3.3 Medicare Part D and Medicaid
3.4 Health Reform Legislation
3.5 Additional Influential Factors
3.6 When Major Drug Manufacturers Suffer, Retail Pharmacy Generics Prosper
4 Competition
5 References
Company Overview

Founded in 1901, Walgreens had revenues of $63.3 billion in fiscal 2009. As of Aug. 31 2009, the company operated 6,997 drugstores in 50 states, DC, and Puerto Rico versus 6,443 a year ago. In fiscal 2009 Walgreens added 544 new drugstores, including 70 by acquision, growing by 8.6%.[3] The company is principally in the retail drugstore business and its operations are within one reportable business segment.



2009 WAG Facilities by Location Type[5]
Product Classes[6]
The company sells three types of products:

Prescription Drugs - 65% of net sales
Non-Prescription Drugs - 10% of net sales
General Merchandise - 25% of net sales
Acquisition of Duane Reade
In the spring of 2010, Walgreens announced that it was purchasing the New York based drugstore Duane Reade. The acquisition strengthens the company's position in New York by adding 257 stores -- all of which will keep their name -- to its already existing 70 Walgreens stores in the New York Metropolitan area. The deal was for $618 million and the assumption of $457 in debt. In 2009, Duane Reade generated $1.8 billion in sales. The acquisition is only expected to boost Walgreen's national market share from 27% to 27.7%.[7][8]

Financial and Operating Metrics

FY2011 Q1 Earnings Summary
WAG reported net income of $580 million, or $0.62 EPS, for the first reporting quarter of FY2011 compared to $489 million same quarter last period.[9] Sales for the quarter also rose 6% to $17.3 billion, with same-store sales increasing 0.8%.[10] This sales figure was on the dot compared to consensus analyst estimates of $17.3 billion.[11]

WAG attributes positive performance to a focus on gross profit margins, cost control and the strategic slowing of new store openings. In particular, by focusing on promotions and pricing on merchandise, WAG has been able to improve its front-end store margins by 0.4% in comparable sales.[12] Prescription sales in comparable stores climbed 0.9%, which led to an overall gross profit margin widening of 0.8% to 28.5%. WAG plans to continue to rid slower selling items and reduce inventory to increase gross profit margins.[13]

Trends and Forces

Tension Between CVS Caremark and Walgreen Over Retail Pharmacy Network

In June 2010, Walgreens announced that it would no longer participate in CVS' drug benefits unit. Walgreens argued that they were not getting their fair share of the profits and alleged that participants had to fill out their prescriptions at a CVS or Caremark mail service instead of at a Walgreens. As a result, CVS Caremark said that it was terminating Walgreens from its retail pharmacy network. In addition, it was also terminating Walgreens' participation in its Medicare Part D. CVS' retail pharmacy network includes 57,000 pharmacies nationwide and allows customers to purchase their prescriptions at any at pharmacy in the network at a reduced price. When Walgreens was apart of the network, CVS Caremark customers could purchase their prescriptions at Walgreens at the CVS price. CVS would then reimburse them and give the network pharmacy a share of the profits. CVS claims that the loss of Walgreen's 7,500 stores does not have a large effect on its network since 92% of Caremark members have access to a participating pharmacy within a 5-mile radius of where they live, with or without Walgreens in the network. Caremark represents 7%, or $4.5 billion, of Walgreen's sales and is something that the company will need to find some way to make up. As of 2009, Walgreens made 20% of all pharmacy transactions and owns more than 50% of the 24-hour/drive-through pharmacies in the US. The termination goes into effect in July 2010.[4][14]

Economic Slowdown Hurts Walgreens
Walgreen's revenues come mainly from pharmacy sales (75% in total) and partly from front store sales. Though medical costs such as prescriptions are not discretionary expenses and thus less vulnerable to an economic downturn, patients still migrate towards lower cost generic drugs instead of more expensive brand name drugs. Walgreens stands to benefit from this, as they receive higher levels of reimbursement from groups like Medicare for generic drugs. Additionally, CVS Chief Executive Tom Ryan says that very little of front store sales comes from "true discretionary sales," meaning that same store sales won't be affected by penny-pinching consumers. As a result, CVS has had increasing net sales and net income through the worst part of the recession. In 2009 and 2008, net sales grew by 13% and 15% respectively and net income grew by 15% and 22% respectively.[3] However, a weak economy also means higher costs. These costs have a large negative impact on the company's bottom line and as a result, net income for 2009 fell 7%.

Medicare Part D and Medicaid
Government cuts in Medicaid and the introduction of Medicare Part D have affected pharmacies like Walgreens.

While Medicare Part D had over 29.3 million enrollees by June 2010 (many of whom who were previously uninsured)[15], many of these used to be Medicaid patients. Medicaid reimburses more for drugs than Medicare, so cuts in the former and increases in the latter have resulted in two competing effects on pharmacies: more customers but lower margins.

At the same time, certain provisions of the Deficit Reduction Act seek to reduce federal spending by altering the Medicaid reimbursement formula for multi-source (i.e., generic) drugs. These changes are expected to result in reduced Medicaid reimbursement rates for prescription drugs. In addition, a class action settlement with two entities that publish the average wholesale prices (AWP) of drugs, AWPs have been reduced for many brand-name prescription drugs effective September 26, 2009. While Walgreen’s has reached understandings with most of its third-party payors to adjust reimbursements to correct for this change in methodology, but state Medicaid programs that utilize AWP as a pricing reference have not taken action to make similar adjustments, resulting in reduced Medicaid reimbursement for drugs affected by the change.

Health Reform Legislation
The Patient Protection and Affordable Care Act, the much awaited and much debated health reform law signed into law on March 30, 2010 by President Obama, may indirectly help US pharmacies by encouraging increased drug utilization, which could boost pharmacy sales.

First, the law is projected to expand insurance to 32 million Americans previously without coverage. Presumably, newly uninsured patients will increase their utilization of drugs. Part of this expansion of coverage is done through an insurance mandate, while part is done by an expansion of Medicaid eligibility. Partially offsetting the benefit accrusing from those newly covered under Medicaid will be the lower reimbursement rates paid by the program to pharmacies relative to cash customers (who pay higher prices but generally buy fewer drugs).

Second, the law partially fills in the Medicare Part D coverage gap, or "donut hole". This is a gap in Medicare prescription drug coverage that kicks in after a moderately high annual threshold of spending ($2,830 in 2010) on prescription drugs is reached. Before then, Medicare generally covers about two-thirds of drug cost; after reaching the gap, the next $3,610 worth of drugs is fully paid for by the patient, after which Medicare covers 95% of all remaining costs. In 2010 Medicare patients that reach the coverage gap will receive a $250 government rebate. Beginning in 2011, they will also receive a 50% discount on branded drugs. Over the next nine years, a series of discounts and benefits will lead to elimination of the gap. This should make sicker patients with high drug spend less price-sensitive and thus also encourage drug utilization. [16]

Additional Influential Factors
Several external trends are currently increasing all pharmacies' revenues across the industry. In addition to increased sales of prescriptions, CVS will benefit as additional foot traffic for the pharmacy naturally leads to increased retail sales in the front end of the store.

Baby boomers are only getting older, and will be more likely to need prescription medications in the coming years
There has been an increase in prescription drug coverage over the last 10 years
Over the next five years, around $50 billion in branded drug sales will lose patent protection, opening them to generics and driving profit margins
When Major Drug Manufacturers Suffer, Retail Pharmacy Generics Prosper
Major drug manufacturers carrying common household OTC medications such as Tylenol, Advil, and Motrin are six times more likely to be purchased by consumers than its same function generics.[17] The main idea behind this thinking, even though most often than not the drug facts are the same, is consumers grew up with these brands and perceive them as safer or more effective than inferior goods.

However, when in the rare case that these trusted household brands are recalled, consumers are often thrown into confusion and will make the switch over to retail pharmacy generics, sometimes permanently. This presents a very valuable opportunity for retail pharmacies. For example, when JOHNSON & JOHNSON (JNJ)'s drugmaking unit McNeil recalled millions of children's and adult versions of those drugs over the past 10 months since late 2009, many consumers have been fraught with confusion as retail pharmacies have been stuck with inadequate supply.[18]

As a result, all major pharmacies such as CVS, Walgreens and Wal-Mart have revamped private label drug manufacturing by five times capacity versus 2009.[19] As traditional JNJ loyalist consumers are forced to use generics, they may realize that they are just as effective as Tylenol and JNJ, except cheaper. As such, these loyal consumers may choose to permanently change over, which presents an extremely lucrative opportunity for retail pharmacies.

Competition

Drugstore competitors to Walgreens include:

CVS/Caremark (CVS) - CVS is the largest drugstore retailer and also has its own PBM business. CVS's sales and profits grew significantly when CVS completed its merger with Caremark, a leading PBM, as a part of its recent acceleration of its physical and geographical expansion. The company continued to aggressively expand with the acquisition of Longs Drug Stores (LDG). CVS is substantially bigger than Walgreens with $99 billion in sales and $3.7 billion in profits.[20]
Rite Aid (RAD) - Rite Aid is the third-largest drugstore chain in the United States, with over 4,800 stores in 31 states. The company makes most of its money from the sale of prescription drugs, but it also sells non-medical items such as cosmetics and greeting cards. In 2009, Rite Aid generated $25.7 billion in revenue but incurred a net loss of $507 million.[21]
MedcoHealth Solutions (MHS)
Express Scripts (ESRX)
In addition to other drugstore retailers, Walgreens also competes for market share with supermarkets, convenience stores, mass merchants, dollar stores, Internet drugstores, and PBMs. In particular, Wal-Mart (WMT) has grown its retail pharmacy business at its retail mega-stores. Wal-Mart is the third largest domestic retailer in terms of pharmacy sales, and it has continued to increase the number of total pharmacies in its installed store base. Wal-Mart also announced a strategy to aggressively undercut prices of generic drugs compared to traditional drugstores such as Walgreens and CVS.


Top Drug Store Competitors
Retail Pharmacy Industry — Competitive Operating Metrics (2009) Walgreen Company (WAG) Rite Aid (RAD) CVS Caremark Corporation (CVS) Wal-Mart (WMT) MedcoHealth Solutions (MHS)
Revenue (billions of USD)
Total Revenue 63.335 25.669 98.729 405.046 51.804
Gross Margin 17.163 6.824 20.380 100.389 4.027
Revenue Growth from 2008 7.29% -3.00% 12.87% 0.95% 16.67%
Income
Net Income 2.006 -506.68 3.696 14.335 1.280
Net Profit Margin 3.17% -1.97% 3.76% 3.66% 2.14%
Income Growth from 2008 -7.00% N/A 15.01% 8.75% 16.08%
Other
Earnings per Share 2.16 -0.43 2.56 3.76 2.61
 
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