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This is one earnings release we've all been waiting for. Drug retailer Walgreen's (NYSE: WAG ) first quarterly report since splitting up with pharmacy benefits manager Express Scripts (Nasdaq: ESRX ) is out. Walgreen saw its earnings drop 8%. The reason? Its decision to break away from the Express Scripts network. No surprises there, really.
In this quarter, Walgreen saw a 6.1% fall in comp prescriptions filled. Last year, Express contributed roughly 88 million out of the 819 million prescriptions filled by the drug retailer -- which makes up more than 10% of the total number of prescriptions filled.
Despite losing out on both revenue and profits, Walgreen has strongly defended its decision to part with Express. But should we go by what management believes? Maybe not.
Bold move -- but is it beautiful?
Walgreen stopped filling prescriptions for Express this year when the two tussled over pricing, resulting in the nonrenewal of the contract between the two parties.
Walgreen's profits in this quarter fell to $683 million, down 8% from last year. Express Scripts' loss accounted for a dip of $0.07 a share, with a milder-than-expected flu season causing a $0.03-per-share drop.
Revenue was almost unchanged from the year-ago period, rising by 0.8%. This resulted from a fall in same-store sales by 2.6%, with prescription comparable sales falling 5%, partially offset by a 1.2% gain in front-end comps.
Where it might hurt the most
Losing Express may have greater implications, as well. It may get in the way of Walgreen's relationship with Medco Health Solutions (NYSE: MHS ) . Walgreen is set to fill 108 million prescriptions for Medco members this year and around 74 million in the next year. But the bad news is that Express and Medco have had their merger approved. Although Express intends to honor Medco's contract with Walgreen, once the two are fully integrated, things may change. "As of today, we're honoring that contract, but we'll have to see going forward," Express Scripts Chief Medical Officer Steve Miller said in the Chicago Tribune. That last part seems pretty clear to me.
I love the way Morningstar analyst Matthew Coffina puts it. He said last week, also in the Chicago Tribune, "You would think that if the merger does go through, the smart thing for Walgreens to do would be to go crawling back to Express Scripts." He also criticizes Walgreen for defending its decision to part ways with Express Scripts.
So what should Walgreen do?
Walgreen's answer to the loss of 85% of its business with Express is to cut costs. CFO Wade Miquelon believes that the company can counterbalance nearly half of the losses by slashing costs. However, I think it'd be better for Walgreen to look for ways to make up lost revenue.
Recently, investors were excited by mere speculation that Walgreen may look to buy fellow retailer Rite-Aid (NYSE: RAD ) . If Walgreen doesn't look for a new source of revenue, it runs the risk of suffering some market-share erosion.
Although Walgreen is standing by its decision to exit the Express Scripts network, it has proved costly for the drug retailer. What do you think? Leave your comments below.
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