Walgreen's Future Profit Potential

Walgreen (NYSE:WAG) posted better than expected sales and announced major progress in its cost-cutting efforts, leading its stock to pop about 10% on Tuesday. Here’s the official release: Walgreen Co. Reports Fourth Quarter 2009 Earnings of 44 Cents Per Diluted Share

Walgreen’s strategic moves are in sync with two important industry trends that I analyze in my (hint, hint) new U.S. Pharmacy Industry: 2009 Economic Report and Outlook:

• The growing advantage of low-cost prescription fulfillment
• The expansion of channel-neutral dispensing models

Both factors—dispensing efficiency and integrated models–also position Walgreen's for more cost-plus deals a la Caterpillar/Walgreens/Wal-Mart.

LOW-COST

Last week, I highlighted Wal-Mart’s view that dispensing services for many maintenance products should be priced as a commodity. See Wal-Mart Explains Its Healthcare Strategy.

Cost leadership is a key strategy for winning in a commodity market. Walgreen is positioning itself to succeed as a low-cost prescription fulfillment provider while also differentiating itself as a one-stop solutions provider. Walgreens Rewiring for Growth program is taking significant costs out of the business without any apparent loss of service.

I’m also keeping a close eye on Walgreen’s POWER initiative, which attempts a best-of-both worlds dispensing strategy. POWER combines the central-fill efficiencies of mail-order pharmacies with in-person consultation from pharmacists in a retail setting. POWER is one factor behind the impressive inventory reductions reported.

I also see that Walgreen grew same-store prescription sales by 4.5% in the quarter ending August 31. It’s well-known that larger, more active pharmacies have lower average costs of dispensing. (See Exhibit 21 in you know where.) Pharmacies with lower costs of dispensing will be better able to operate with lower levels of reimbursement than higher cost pharmacies.

CHANNEL NEUTRAL

Walgreens also announced a new effort to shift 90-day maintenance scripts from mail-order into a retail store format, a trend being encouraged by both CVS Caremark and Wal-Mart. This is not really new because Walgreen’s Advantage90 program launched in 2003. But the renewed emphasis connects to the low-cost story and an emerging challenge facing Pharmacy Benefit Managers (PBMs).

See Walgreens Launches National Initiative for 90-Day Prescriptions at Community Pharmacies, which states:

“As part of this program, Walgreens pharmacists will work with patients, physicians, insurers, employers and managed care organizations to implement a comprehensive 90-day at retail prescription program for maintenance medications including, where appropriate, the conversion of traditional 30-day chronic care prescriptions into 90-day prescriptions.”

Big Picture: Convergence within the pharmacy business is creating channel-neutral dispensing models.

As I note in The Impact of Walmart's National Mail Pharmacy, Walmart and CVS Caremark (with Maintenance Choice) are now both pursuing strategies that eliminate the traditional out-of-pocket cost difference for consumers and payers between mail and store-based pharmacy. On the conference call, Walgreen’s highlighted its reluctantly launched Prescription Savings Club as another factor driving the shift to retail.

This dynamic will affect PBMs, which rely heavily on mail-order profits to fund other activities. I forecast that growth in mail-order prescriptions will lag some other channels because of increased competition from retail store-based pharmacies. See Exhibit 15 in...wait for it... my new report.

RANDOM COMMENTS

• I heard some very intriguing hints about the future WAG-CAT network structure on the earnings call. If you purchased the U.S. Pharmacy Industry: 2009 Economic Report and Outlook, compare Walgreen’s CFO Wade D. Miquelon’s responses on the call to pages 42-44 in my new report.
  
  
• Walgreen’s projected a “worst case” impact of $80 to $90 million from the AWP rollback. Similar to my comments in AWP Goes Boom, the biggest impact will be from state Medicaid programs, not the commercial market.
  
  
• You may have noticed a few subtle hints regarding my new report. If you haven't yet broken down and purchased it, check out the Table of Contents to get a better sense of what's inside. Sales so far have been really strong, so you should at least know that your competitors and many industry analysts/strategists are already reading it.