Can Express Scripts Really Count on Walgreen, CVS, and Rite Aid?

Express Scripts (ESRX) will release its quarterly report on Thursday, and investors have bid the stock to new all-time record highs in recent months. The big question facing the company is whether it can continue to use its relationships with Walgreen (WBA -1.18%), Rite Aid (RAD -51.21%), and CVS Caremark (CVS -0.65%) to drive profits. With the drugstore chains seeking their own fortunes in the ever-changing prescription drug space, pharmacy benefits managers like Express Scripts could eventually see competitive pressure on their earnings.

Express Scripts has huge influence in the pharmacy-sales industry, as it aptly demonstrated when Walgreen balked at renewing its contract with the pharmacy benefits manager. Walgreen quickly lost customers to Rite Aid and CVS, forcing it to negotiate a deal with Express Scripts to try to get those shoppers back. Yet with so much at stake in the drugstore business, a more concerted effort from the big three retail chains could change the industry's dynamics against the pharmacy benefits manager. Let's take an early look at what's been happening with Express Scripts over the past quarter and what we're likely to see in its report.

Stats on Express Scripts

Source: Yahoo! Finance.

How long can Express Scripts earnings grow so fast?
Analysts have largely held their view on Express Scripts earnings steady in recent months, keeping their third-quarter estimates stable and moving full-year 2013 and 2014 projections by just a single penny per share in opposite directions. The stock has fallen from its summer highs, though, giving back 4% since late July.

Express Scripts has found huge profits from acting as a middleman between drug manufacturers and drugstore chains. The company wields influence in both directions, as drugmakers rely on contracts with Express Scripts in order to make their products available to pharmacy benefits manager members, and Rite Aid, Walgreen, and CVS Caremark depend on those PBM members being able to fill their prescriptions at their respective drugstore locations to drive sales. That model has raised critical concern among some consumer advocates, but investors have been pleased at its success for Express Scripts.

Express Scripts' real problem comes from competition from other pharmacy benefits managers. Revenue fell 4% during the company's second quarter largely because UnitedHealth Group (UNH 1.35%) pulled its PBM business into its in-house OptumRx unit. In addition, CEO George Paz cited health-insurance exchanges, new regulation, and changes in the prescription drug market as potentially challenging Express Scripts' business.

In particular, the health-care exchange business opens avenues for Rite Aid, Walgreen, and CVS Caremark to establish new relationships with private exchange operators. For instance, Aon Hewitt recently signed up Walgreen to participate in its corporate health exchange, essentially cutting out Express Scripts as a middleman. The exchange model is picking up steam, and drugstore chains eager to gain leverage over PBMs will inevitably look for alternatives that can help with contract negotiations.

In the Express Scripts earnings report, watch to see how the opening of Obamacare's health insurance marketplaces affects the way the company discusses its future prospects. With so much at stake from the new legislation, it's important to see whether the Affordable Care Act gives drugstore chains like Walgreen, CVS, and Rite Aid more power over what they pay Express Scripts.

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