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Minyanville Mailbag: Walgreens Edition

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This has to be the morning after?

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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":

Professors,

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.

Jim


Thanks for the great email, Jim!

No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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