Things Aren't Looking Great For Walgreen

The nation's largest drugstore chain, Walgreen (NYSE: WAG), saw its first-quarter profits drop 4.5%, largely because of the sluggish flu season and its imminent breakup with Express Scripts (Nasdaq: ESRX). Its decision to discontinue operations with Express has cost Walgreen, sending shares down over 22% in the last six months. The two companies reached an impasse back in June, and their contract expired on Jan. 1. Let's delve a little deeper.

No colds, no income
Revenue crept up just 5% to $18.2 billion due to a meeker-than-expected cough, cold, and flu season. The number of flu shots Walgreen administered this year has dropped from a year ago. As of November 2011, it administered nearly 5 million shots, whereas at the same time last year, it had administered 5.6 million. Selling, general, and administrative expenses also rose by 5%, largely because of the acquisition of drugstore.com. All this eventually resulted in the company's bottom line sliding down 4%.

But the major problem for the drug retailer is that for this next year it will not be filling the nearly 90 million Express Scripts prescriptions it did last fiscal year.

Express split
Sans Express, Walgreen will be without a pharmacy benefit manager, and to add to its woes, Express is set to join forces with Medco Health (NYSE: MHS). The marriage between the two will create the largest pharmacy benefits operator in the U.S., and could result in Walgreen losing Medco customers over time.

As of last year, Express contributed $5.3 billion in revenue to Walgreen, which is roughly 7% of what Walgreen generated overall. Thus, it stands to lose a hefty chunk of its overall revenues without Express. This may work to the advantage of Walgreen's peers, as customers who are on the lookout for prescriptions can flock to nearby Rite Aid (NYSE: RAD) and CVS Caremark (NYSE: CVS) stores. With nearly a third of Rite Aid locations within a mile of a Walgreen, it should be a relatively easy switch for many customers to make. CVS, with its 7,304 retail drugstores, will also create a compelling switching case for many customers.

Impending loss
Walgreen said it may take a hit of $0.21 a share in the next fiscal year -- assuming that it can hold on to at least 25% of its customers with Express Scripts plans. Analysts expect that the breakup may cost Walgreen nearly $4 billion in revenue next year.

So, things aren't looking great for Walgreen. It will be interesting to see how the company copes without Express.

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