Can Walgreens' Retail Pharmacy USA Segment Drive Q1 Earnings?

Walgreens Boots Alliance, Inc.'s WBA Retail Pharmacy USA division continued to witness comparable prescription growth as well as strength in retail prescription market. Several planned developments, early benefits of new pharmacy contracts as well as an increase in volume owing to previously announced pharmacy partnerships have been driving growth in this space over the past few quarters. We expect this momentum to get reflected in fiscal first-quarter 2018 results, which are scheduled for release on Jan 4.

Moreover, rising expenditure on prescription drugs and growing demand for specialty drugs have been strengthening the retail pharmacy market. The Centers for Medicare and Medicaid Services report published by Advisory Board expects this trend to continue. Per the report, prescription drug spending is projected to grow roughly 7% between 2018 and 2019.

Challenges in the Retail Pharmacy USA

Per management, the pharmacy business is affected by reimbursement pressure and a shift in pharmacy mix toward 90-day at retail (one prescription that is equivalent of three 30-day prescriptions) and Medicare Part D prescriptions. Moreover, the company expects these factors to affect first-quarter fiscal 2018 results.

Moreover, collaborations among generic producers and a rise in generic dispensing rate (the proportion of all generic prescriptions to total number of prescriptions dispensed) raise caution.

The speculated entry of Amazon.com, Inc. AMZN in the retail pharmacy market has aggravated matters. To counter competition, Walgreens Boots will have to add more digital and customer-friendly programs.

Intensifying competition owing to mergers and acquisitions is also a matter of concern. In this regard, CVS Health CVS announced a historic decision to acquire health insurance giant Aetna AET. Following the announcement of the CVS-Aetna deal, another leading health service company — Optum, part of the UnitedHealth Group UNH — announced plans to acquire DaVita Medical Group, a leading independent medical group and a subsidiary of DaVita Inc. DVA. Moreover, it is being speculated that Wal-Mart Stores, Inc. WMT might soon announce the acquisition of health and well-being company, Humana Inc. HUM to fend off competition.

Steps to Counter Obstacle

Walgreens Boots has been leaving no stone unturned to counter challenges.

In this regard, the company has been developing and expanding relationships with commercial third-party payers to permit new and enhanced market access via participation in pharmacy provider networks. Notably, CVS health has announced plans to set up a new 30,000-store performance-based pharmacy network fixed by CVS Pharmacy and Walgreens Boots, as well as up to 10,000 community-based independently-owned pharmacies in the United States.

Per management, the prescription volume impact of new agreements and relationships typically is incremental over time. The company's 90-day at retail prescription drug offering is a lower margin one in comparison to 30-day prescriptions. However, it helps the company tap into opportunities pertaining to patients with chronic prescription needs. It also offers increased convenience and cost efficiency. The company's U.S. loyalty program, Balance Rewards, also bodes well. Notably, as of Aug 31, 2017, the number of active Balance Rewards members totaled 88.2 million.

Rite Aid Deal a Positive

We currently look forward to the company's agreement to purchase a limited number of Rite Aid Corporation RAD stores. While the transition process of these stores is underway, the company expects this phased acquisition to be completed by spring 2018. Notably, Walgreens Boots has purchased 1,932 stores, three distribution centers and related inventory from Rite Aid for a total transaction value of $4.375 billion.

Although the deal is not going to impact the yet-to-be-reported quarter's results, a number of aspects of it should prove beneficial in 2018. In this regard, the final Rite Aid deal agreement retained the clause to allow Rite Aid to buy generic drugs sourced through a Walgreens Boots' affiliate at a cost equivalent to Walgreens Boots' for about 10 years. Also, Rite Aid will provide Walgreens Boots with certain transition services for up to three years post deal closure.

This apart, the deal's financial value is quite attractive. Post the transaction's initial closing, synergies of $300 million are expected to be realized within four years. This will be derived primarily from procurement, cost savings and other operational matters.

Per Walgreens Boots, this modified merger contract will extend its growth strategy and offer operational plus financial benefits. It will also help the company expand and optimize retail pharmacy network in key U.S. markets, including the Northeast. Notably, the stores to be purchased are located primarily in the Northeast and Southern United States, while the sites of three distribution centers to be bought are in Dayville, CT; Philadelphia, PA and Spartanburg, S.C. However, to achieve the desired results, the company will have to incur huge expenditures to fully integrate and rebrand the retained stores.

Here is what our quantitative model predicts:

Walgreens Boots is likely to beat earnings in first quarter. This is because a stock needs to have both a positive Earnings ESP  and a solid Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 (Hold) for this to happen. But that is not the case here, as you will see below.

Zacks ESP:  Walgreens Boots has an Earnings ESP of +3.97%. You can uncover the best stocks to buy or sell before they're reported with our Earnings ESP Filter.

Zacks Rank: Walgreens Boots carries a Zacks Rank #2. You can see the complete list of today's Zacks #1 Rank stocks here.

Share Price Movement

Walgreens Boots has outperformed the broader industry  in the past three months. The stock has lost 5.4% as compared to the broader industry's 7.8% fall.