WBA, CVS, RAD: There Are Simply Too Many Pharmacies & Now it Starts to Matter

Richard

Retail prescription margin growth has outpaced CPI since 1990, drug pricing since at least 2001, and any other major US retail setting’s gross margin growth since at least 2004

It’s not because we lack enough pharmacies, it’s because traditional drug benefit plans (which cover 92% of Rx’s) mean customers face the same Rx costs no matter which store they choose. Under narrow (or preferred) networks this all changes – pharmacies willing to dispense at lower margins can, for the first time, gain traffic

Now that retail dispensing margins are real money, engineering drug benefits to reduce dispensing margins makes great sense. We believe narrow retail networks can save +/-7% over all-inclusive networks. If this doesn’t sound like a lot, bear in mind that all the effort PBMs and HMOs put into managing formularies and negotiating drug rebates yields an average savings of about 8%

Using the federal standards for pharmacy proximity (90% of beneficiaries within 2 miles of a pharmacy for urban, within 5 miles for suburban, and within 15 miles for rural), we estimate that 34% of US retail pharmacies could be closed before these proximity standards are no longer met

As retail networks narrow, chains (WBA, CVS, RAD) can profitably dispense at lower margins than independents, so the long trend of independent closures is likely to continue. However mass merchants and supermarkets presumably are willing to dispense at even lower margins than the chains. Chains get 63-69% of sales from prescriptions, mass merchants and supermarkets get only 6-10% – meaning mass merchants and supermarkets can cut dispensing costs and make it up on front store traffic, but the pharmacy chains cannot

The average distance from a WBA pharmacy to a mass merchant or supermarket with a licensed pharmacy is only 1.3 miles; for CVS it’s 1.9 miles, and for RAD 2.5 miles. Within the applicable minimum proximity radius (2 mi urban, 5 mi suburban, 15 mi rural) the average WBA and/or CVS pharmacy will find 9.2 mass merchants and/or supermarkets with pharmacies; the average RAD pharmacy will find 7.9

RAD’s earnings are most reactive to falling dispensing margins; a 1 percent change in pharmacy gross margin percentage would, all else equal, have lowered RAD’s 2014 OPEX by 24.1%. For WBA the fall in OPEX would have been 11.5%, for CVS 5.3%

Consensus expectations for near term (2015/16) gross margins fell in the wake of late-summer warnings by WBA and RAD about the effects of generic acquisition costs and narrowing networks. However consensus now expects gross margins to be stable over the mid- to longer-term, which fails to account for the likelihood that narrow retail pharmacy networks will gather more beneficiaries with each passing year, creating a steady source of mounting gross margin pressure

For our full research notes, please visit our published research site

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