The Coming Flu Season Will Strengthen These Companies

The U.S. flu season, which usually starts in October and peaks in January, is right around the corner. The number of flu deaths per year varies, between 3,000 to 49,000 depending on the circulating strains. Last year's flu season was particularly deadly, claiming the lives of 164 children, up from 34 pediatric deaths in the previous year.

Yet this year, reports from the Centers for Disease Control and Prevention will be delayed due to the government shutdown -- keeping everyone in the dark regarding the scope of this year's flu season. However, as investors, we can analyze drugstores and pharmaceutical companies to find the companies that will benefit the most from an increased demand for flu vaccines and medications.

A shot in the arm for drugstores
Walgreen (NYSE: WAG  ) , the largest drugstore chain in America, recently reported that its September sales rose 8% year over year, with a same-store-sales increase of 7.4%. Its pharmacy revenue increased 10.2% thanks to 1.9 million flu shots -- a 19% jump from the 1.6 million shots it administered in September 2012.

Those numbers indicate that Walgreen's strong top and bottom line growth from last quarter would continue. For the fourth quarter ended Aug. 31, Walgreen posted a 15.9% jump in earnings on a 5.1% gain in revenue. The company's same-store-sales rose 4.6%, while pharmacy same-store-sales rose 7.1%. Investors have noticed Walgreen's strong performance, and shares have climbed 13% over the past month.

Meanwhile, Rite Aid (NYSE: RAD  ) , the third largest drugstore chain, reported a 1.9% year-over-year increase in September same-store sales. The company's pharmacy revenue rose 3.1%, partially fueled by an increase in flu shots.

Rite Aid's robust September sales also indicate that the stock's 49% climb over the past month shouldn't slow down anytime soon. Rite Aid has impressed investors with its return to profitability. During its second quarter, Rite Aid reported adjusted earnings of $0.08 per share, compared to a loss of $0.05 in the prior year. Revenue edged up 0.8% as same-store sales remained flat year over year. However, pharmacy sales climbed 1.7% thanks to increased sales of generic drugs.

The second largest chain, CVS Caremark, does not report revenue on a monthly basis, although more flu shots should boost its quarterly sales. Both Walgreen and Rite Aid stated that flu shots leveled off after the initial surge in September.

A closer look at the two main flu treatments
On the pharmaceutical side of things, all eyes are on Roche's (NASDAQOTH: RHHBY  ) leading flu treatment, Tamiflu. It was developed by Gilead Sciences (NASDAQ: GILD  ) and licensed to Roche in 1996. Gilead currently receives a 10% royalty on Tamiflu sales.

During the first half of 2013, which included last year's flu season, sales of Tamiflu climbed 79% year over year to $420 million due to a stronger-than-expected flu season and the H7N9 outbreak in China. Despite that growth, Tamiflu sales only accounted for 1.6% of Roche's top line, which is primarily generated by oncology treatments.

For Gilead, higher sales of Tamiflu contributed to a 31% year-over-year increase in royalty revenue to $106.5 million during the second quarter. Yet just like Roche, that royalty revenue was not significant to Gilead, only accounting for 3.8% of its second-quarter revenue, which mostly comes from its HIV franchise.

Meanwhile, Tamiflu's closest competitor, Relenza, has fallen far behind. Relenza was developed by Biota Pharmaceuticals, marketed by GlaxoSmithKline (NYSE: GSK  ) , and approved in 1999. At one point, the drug was considered to be the next blockbuster flu treatment, since it was cheaper, and showed better efficacy rates during clinical trials than Tamiflu.

However, Relenza was more difficult to administer, requiring a diskhaler compared to Tamiflu's pill and liquid forms. Due to its inhaled form, Relenza aggravated respiratory problems in some patients, and it could only be given to children over the age of seven, whereas Tamiflu could be administered to babies as young as two weeks old. These factors caused Relenza's sales to plunge, generating only $13 million in revenue in all of 2006 -- a year that Roche reported $770 million in Tamiflu sales in the first half alone. Tamiflu went on to hit peak sales of $3 billion in 2011 due to the H1N1 swine flu, as Relenza slowly faded away.

Tamiflu and Relenza are currently the only two flu treatments recommended by the CDC. Both can be used as a preventative measure as well as a treatment. Although pharma investors won't likely see a huge boost for Roche and Gilead as a direct result of higher sales of Tamiflu, it can still provide both companies with useful extra revenue, which can be reinvested elsewhere.

The Foolish takeaway
As the flu season approaches, drugstores like Walgreen and Rite Aid will directly benefit from the increase in flu shots, which could also turn around the lagging front end same-store sales that I addressed in a previous article. Investors should view these drugstores as the primary beneficiaries of a strong flu season.

Meanwhile, big pharma and biotech companies like Roche and Gilead Sciences still play a crucial role in treating the flu and its various seasonal strains, albeit the resulting revenue gain will be limited and cyclical. Last but not least, companies with large consumer health divisions, such as Johnson & Johnson, GlaxoSmithKline, and Novartis, could see higher sales of over-the-counter cold medications as well.

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