V iagra is just the latest casualty.CVS Health ( CVS ) on Aug. 3 removed the blockbuster erectile dysfunction drug and 30 others from its 2016 “formulary” list. The list names drugs that its pharmacy benefit management business, CVS Caremark, agrees to cover under its prescription benefits program for health insurance companies such asAetna ( AET ).
The exclusion list, drugs not covered, has now ballooned to 124. Until CVS began its PBM blacklist in 2012, there were no known drug exclusion lists, according to drug industry tracker Drug Channels.
“It’s the competition of forces of wanting the best treatment and best medicine, but doing it in a way that’s cost effective,” Wolfe Research analyst Scott Mushkin told IBD.
Costs are rising, pressured in part by specialty drugs such as genetically engineered or “biosimilar” drugs that target cancer, hepatitis C and other diseases, and cost $3,000 to $4,000 per prescription, vs. less than $200 for most prescriptions. Analysts say these costly specialty drugs will account for 50% of all prescription revenue by 2018.
At the same time, costs are expected to feel increasing upward pressure because “as baby boomers age, there will be a real push for health care use,” IBISWorld analyst Sarah Turk said.
Pharmacies and PBMs want to carry a variety of patented drugs, biosimilars and generics, she added.
In 2011-12, some $250 billion worth of drugs went off patent. Among those werePfizer’s ( PFE ) cholesterol fighter Lipitor andAmgen’s (AMGN) arthritis blockbuster Enbrel.
For retail drugstores, that “patent cliff” has been a boon. The change ramped up sales of generics, and launched a wave of new development by major drugmakers to replace drugs on which they’d lost patent protection.
Meanwhile, “We estimate 30 million more customers will gain prescription coverage by 2020,” as a result of the Affordable Care Act, Jefferies analyst Mark Wiltamuth said. “This means better volume for drug stores over time.”
Despite the Affordable Care Act, and partly because of the thicket of regulations it’s created, some analysts contend that health care costs are not likely to fall any time soon.
But a lot of medical costs are paid by the government through Medicare, Medicaid and other programs, and the government is putting added pressure on pharmacies and PBMs to cut costs, Mushkin said.
Despite those cost pressures, the retail drugstore industry is thriving.
“It’s a fairly positive outlook,” Jefferies’ Wiltamuth said, “driven by health care reform, aging of the baby boomers, the generic drug wave and specialty drugs.”
An Industry In Transition
The 25,701 U.S. retail drugstores employ 721,320 nationwide. Total annual industry revenue is currently estimated by market tracker IBISWorld at about $263 billion, with a 1.2% annual growth rate.
One of the biggest recent changes for drugstores is the drive to become health and wellness centers.
CVS opened its first Minute Clinic in 2000 and has ramped them up since. Medical practitioners there treat the flu, as well as eye and ear infections and other ailments.
To align itself with that commitment to health, CVS last September became the first national drug store chain to quit selling tobacco products.
Walgreens offers medical services such as inoculations, free AIDS testing in many cities and the Balance Rewards program, a weight-loss program that rewards members for healthy food and activity choices.
The three big players account for nearly half of all prescription revenue. CVS CEO Merlo said on the company’s Aug. 4 earnings call that CVS had a 21.6% retail pharmacy market share at the end of the second quarter. No. 2 Walgreens Boots Alliance has about 19% and Rite Aid accounts for 7% to 9%, depending on the analyst report.
Other entities that fill prescriptions and act as drugstore outlets include local independent neighborhood pharmacies. But as the industry has consolidated, many small independents have been acquired or driven out of business.
The top three chains reported a combined total of more than $242 billion in sales in 2014, but the drug store industry is expected to continue consolidating.
Another big piece of the market is held by in-store pharmacies operated by big box discounters such asCostco Wholesale (COST) andWal-Mart (WMT), and grocers likeKroger (KR), the nation’s largest supermarket operator under its namesake as well as Ralph’s, Fred Meyer and other branded chains.
CVS Health in June announced that it was buyingTarget’s (TGT) money-losing 1,660 in-store pharmacies for $1.9 billion. CVS plans to rename and operate them under the CVS Pharmacy brand, adding them to the more than 7,400 drugstores it currently operates in 44 states.
On May 21, a month before the Target buy, CVS confirmed that it would buyOmnicare (OCR), a pharmacy-related services provider for seniors, in a deal valued at $12.9 billion including $2.3 billion in Omnicare debt that CVS will take on.
Both of those deals are expected to close by the end of the year.
CVS reported Q2 earnings that beat estimates, its fifth quarter in a row of better-than-expected profit growth. But revenue for the quarter missed projections and it offered weak guidance for the current quarter. That mix drove its stock down 2.5% on Aug. 4. CVS stock climbed to an all-time high 113.65 on July 29 before pulling back 6%.
Walgreen changed its name in December to Walgreens Boots Alliance, after buying the rest of European health and beauty retailer Boots Alliance that it didn’t own for nearly $16 billion. The merged company operates more than 12,800 stores in 11 countries.
Recently, it’s been rumored that Walgreens may be mulling an offer for Rite Aid to put the combined company on more even ground with CVS, for which analysts estimate revenue north of $150 billion this year, vs. Walgreens’ 2015 estimate of $103.4 billion and estimates for Rite Aid of nearly $31 billion for its fiscal 2016.
“Walgreens is on record saying they would like to be acquisitive,” Wolfe Research’s Mushkin said. “Given the dynamics of the market I would say the smaller players, whether Rite Aid or someone else,” could be an acquisition target, he said.
That combination would make the U.S. retail drug store industry basically a duopoly. But IBISWorld’s Turk says the federal government might not object, given the other options for consumers such as independents and in-store pharmacies.
She noted that “CVS was allowed to acquire Target,” making it far-and-away the world’s largest drug store retailer.
Walgreens, like CVS, in early July reported quarterly earnings that topped estimates, while a 48% revenue gain stopped short of expectations. It’s recently hit a series of new highs, the latest on Aug. 5 just after clearing a cup base. Shares have since pulled back below the base’s 93.52 buy point.
Rite Aid in February became the second retail drug store chain after CVS to buy a pharmacy benefit manager when it agreed to pay about $2 billion cash and stock for EnvisionRx, which has roughly $5 billion a year revenue.
“Owning a PBM will strengthen their ability to price drugs,” Turk said.
Fewer Doctors, Higher Margins
Retail drugstore industry revenue has grown at a mild 1.2% pace recently but IBISWorld forecasts that growth will accelerate to 2.9% from 2015 to 2020, hitting $303.3 billion that year.
Profit is expected to rise slightly from 2.8% of industry revenue to 3.1% in 2020 as the industry dispenses more high-margin drugs.
One trend spurring this growth is a shortage of physicians in the U.S., according the Department of Health and Human Services. That will enable more pharmacies and drugstores to provide preventive care services.
“Pharmacies and drugstores will prove to be indispensable over the next five years, as the industry will be an integral component in providing preventive care,” Turk said.
Follow James DeTar on Twitter: @IBD_JDeTar