On Tuesday, shares of Walgreen (WAG: Charts, News, Offers), the largest drugstore chain in America, tumbled over 6% despite a market-wide rally. Shares have lost approximately a fourth of their value in a mere three months. The reason is a familiar one to investors, carrying over from last quarter – its continuing conflict with former partner Express Scripts (ESRX: Charts, News, Offers) has clouded the company’s once clear growth prospects. At the same time, the company reported solid fourth-quarter results which beat on both profit and revenue. Walgreen reported earnings of 87 cents per share, or $792 million, a 69% increase from the 49 cents per share, or $470 million, it reported a year earlier. Excluding one time items, Walgreen reported earnings of 57 cents per share, topping analysts’ estimates of 55 cents per share. Revenue increased 6.5% to $18 billion, and same-store sales rose 4.4%. However, gross margins slipped slightly from 28.4% to 28.2%. Strong same-store sales, openings of new stores and its acquisition of Duane Reade, a New York City-based pharmacy chain, helped boost its earnings.
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Walgreen’s ongoing conflict with Express Scripts, its former pharmacy partner, has been a costly one. Express Scripts is a pharmacy benefit manager (PBM), which processes all claims for prescription pharmaceuticals for Walgreens stores. Walgreen refused to renegotiate its contract with Express Scripts when the latter demanded higher reimbursement fees, which Walgreen claimed would dent its margins. As a result, credit rating agency Moody’s – in its latest downgrade spree – lowered its outlook on Walgreen, claiming that the loss of Express Scripts could put $5.3 billion in annual revenue at risk. In his comments regarding the fourth quarter results, CEO Greg Wasson stressed that the company is still on track to grow its customer base throughout fiscal 2012, while softening the lingering issue of Express Scripts. Company officials have only stated that the two sides remain “miles apart” from any tentative agreement. Wasson has stated that the company is only prepared to return to negotiations if Express Scripts agrees to provide “fair compensation.”
While the conflict with Express Scripts has been old news since last quarter, the conflict intensified in September, dashing investor hopes that Walgreen could peacefully resolve defuse the situation, as it had done with a similar situation with CVS (CVS: Charts, News, Offers) Caremark last year. Under the current agreement, Walgreen’s contract with Express Scripts will expire on January 1, 2012. In addition, Express Scripts is suing Walgreen over the alleged breach of contract. Wasson stated that the company has been in negotiations with pharmaceutical companies to form direct relationships, rather than going through an established middleman like Express Scripts, which would bolster its margins considerably. This kind of agreement would be beneficial for both Walgreen and pharmaceutical companies, but could cause severe breaches of contracts between Express Scripts and its pharmaceutical partners.
Analysts have expressed dismay that Walgreen and Express Scripts seem set on doing their dirty laundry in public, exacerbating investor anxiety. The loss of Express Scripts would amount to a loss of 20 cents per share from full year 2012 earnings. In addition, Express Scripts current attempt to acquire competitor Medco Health Solutions (MHS: Charts, News, Offers) could knock off an additional 20 cents per share. Express Scripts shares have also plunged due to the standoff, losing over a third of their value over the past three months. Technically, Walgreen is still strong on fundamentals, but the lack of progress in its current conflict and the murky alternatives offered have spooked investors, especially during a market downturn. However, if the market firms up, Walgreen is poised for a strong rebound if it can solve its problems – preferably behind closed doors.
Other News About WAG
Walgreen profit jumps, shares fall on deal concern
Walgreen shares get battered on old news.
Moody’s lowers Walgreen outlook
Moody’s downgrades Walgreen in the latest downgrade spree.
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Leo Sun is long-time market follower and finance writer. He regularly contributes to the Stock of the Day analysis.
