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Minyanville Mailbag: Walgreens Edition


This has to be the morning after?


Walgreens (WAG) is bouncing 2-bits in early trading as analysts debate the impact of Wal-Mart's (WMT) well-hyped move to cut pricing on generic, monthly cash and carry drugs to $4 per month. While JP Morgan (JPM) is among the few published analysts taking a dim view of the impact on drugstores, Prudential (PRU), Goldman (GS) and Deutsch Bank (DB) are calling yesterday's beatings overdone. Pru even goes so far as to say the move may help the bigger drug chains by culling the herd of local drug stores with less capacity to compete.

As I noted on Fast Money last night, the big WAG drop on 7x average daily trading volume yesterday is often a sign of capitulation in a stock, rather than the beginning of a further move lower in a stock. From where I'm sitting (generally in the back of a car, a make-up chair or a hotel), competing on price in drugs is no more of a panacea for Wal-Mart than what the company has done with groceries. It kills the local, inefficiently priced stores and drives some traffic but doesn't advance the ball in terms of margin. Customers willing to work through an ill-kept parking lot and 200,000 square feet of a Wal-Mart store in order to save a couple of bucks are pretty much not high-margin impulse shoppers, almost by definition.

But I could be wrong (yes, despite being on TV). A well-reasoned opposing view comes from Minyan Jim "Dandy":


I was the Controller for a large drug store chain. Here are my thoughts on Wal-Mart's new generic drug pricing plan.

1. The new pricing applies to cash paid prescriptions which represent a small portion of prescription drug sales, $4 for a 30 day supply of drugs is likely less expensive than many insurance co-pays. For example, rather than getting a generic prescription filled at Walgreens and paying a $10 co-pay, a customer may choose to pay $4 at Wal-Mart without insurance.

2. More importantly, Wal-Mart's new pricing plan tells me it is willing to sacrifice its pharmacy department profits to drive customer count. This might be just the tip of the iceberg. WMT may choose to get much more aggressive on contract pricing for third party insurance plans in exchange for exclusive rights to fill prescriptions for those plans. This could force other chains to match the pricing to retain the contract (thus forcing down margins) or lose the revenue entirely.

My opinion is that this is potentially very bad news for the retail prescription drug business. This is a business with substantial overcapacity (a drug store on every corner in many metro areas) and it now appears a pricing war is about to break out.

For a company like Walgreens, who relies on prescription drug sales for 65%+ of total revenue and trades at 28 times earnings, today's 7% drop in the stock price was more than justified in my opinion. I would not own this stock at this juncture.

I enjoy Minyanville. Keep up the great work.


Thanks for the great email, Jim!

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No positions in stocks mentioned.

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