On December 21, 2012, Walgreen (NYSE: WAG) released first quarter 2013 results that were dismal, disappointing Wall Street expectations and sullying the holiday mood of its investors. GAAP first quarter earnings per share were $0.43, which was 20 cents below what they earned for first quarter 2012, at $0.63 per share. 2012 results on the other hand were higher than first quarter 2011 results where Walgreen earned $0.62 cents per share.
While they crowed about the results in their 2012 earnings report, they also blamed the “decision to be no longer part of Express Scripts (NASDAQ: ESRX)” for a 2 cent impact to pharmacy sales and expenses. Guess who they are blaming for this year’s woes?
They talk about "ongoing Express Scripts impact," and disruption from Hurricane Sandy. However, they say that their performance was getting stronger despite these impacts. An ordinary investor could be excused for thinking Walgreen is an evergreen stock.
No longer evergreen
When Walgreen left Express Scripts, they felt that they would be impacted more in the long term if they stayed despite short term impacts.
Subsequently, for sparsely explained reasons, they decided to rejoin the Express Scripts network by agreeing to a new contract. However, it's hard to make an informed judgment about the new contract, as key details have not been shared publicly.
I wrote earlier in October 2012 that it appeared that the new agreement contained provisions that would allow Express Scripts to exclude Walgreen from some of their network offerings. I based this from my own experience because while I was eagerly looking forward to going back to my local Walgreen store for my prescriptions, Express Scripts informed me that it would no longer be possible.
Express Scripts told me that my plan sponsor chose a network that excluded Walgreen for cost reasons. This seems to go against the argument Walgreen offered in their 2012 earnings report, which seemed to indicate a general preference by plan sponsors for Walgreen. Walgreen went so far as to suggest that many plan sponsors were changing loyalties due to their desire to maintain access for their plan subscribers.
Seemed like a pretty good story right? If that was indeed true, then one is left wondering why Walgreen would accept anything less than an unaltered contract that existed prior to their dispute with Express Scripts. Something does not add up and it still doesn’t in their latest 2013 Q1 earnings call transcript.
Competitors that benefit
Rite Aid (NYSE: RAD) appears to have genuinely benefited from the spat that occurred between Walgreen and Express Scripts. Rite Aid reported third quarter fiscal 2013 earnings of $0.07 per share that was up a penny from earnings a year ago for the same quarter. Further, Rite Aid raised earnings guidance for the entire fiscal year 2013. Wall Street liked the results and shares rallied. CVS Caremark (NYSE: CVS) reported third quarter 2012 results that were equally strong & they raised guidance as well.
I mentioned in my earlier post that both Rite Aid and CVS reported that they were picking up prescriptions from former Walgreen customers who were served by Express Scripts. This appears to be continuing and, furthermore, even as Express Scripts and Walgreen have patched up, former Walgreen customers are not returning. It’s not that they don’t want to; perhaps they can’t thanks to the seemingly lopsided contract that Express Scripts negotiated.
The future of Walgreen
Walgreen will need to deal with the likely permanent loss of customers who have migrated over to competitors. They have tried to play catch-up through the introduction of new loyalty programs such as their Balance Rewards program, which according to them has 45 million enrolled members since its recent introduction. However, CVS Caremark and Rite Aid have had an head start on this front.
Walgreen has a large footprint with over 8,000 stores across the country. For frequent travelers like me, it used to be a godsend. However, in a highly competitive retail pharmacy climate, every customer counts and the loss of Express Scripts customers will be a huge hit to their bottom line.
Walgreen management disagrees with the assessment that the Express Scripts fiasco has had a damaging impact and insists that customers are being regained. CEO Greg Wasson asserted that this quarter was a “turning point” and that the company was quickly regaining lost customers at the rate that they had shifted to competitors.
However, his response to the question from an analyst from Credit Suisse about sums it up. The analyst asked about the seeming “disconnect” between Walgreen’s claims about regaining lost customers and competitor claims about winning over and retaining these customers. Mr. Wasson said that he could not “help you with that disconnect,” but he is “happy where we are.”
Walgreen executives further said that they were optimistic and that no one can predict the rate of retention (by competing pharmacies). I guess that's also what we should do as investors. The best we can do is to be optimistic and wait, watch, and see.
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