The sudden divergence in the fortunes of retail drugstore chains might be summed up this way: "Where there are smokes, there's fire (or someone getting fired).
The rebranded CVSHealth (CVS) in early September stopped selling cigarettes, following up on a plan announced in February, absorbing a $2 billion-a-year hit to its top line. The move, which won CVS a pat on the back from the White House, didn't get in the way of CVS bumping up its profit outlook in August.
Amid the government and private-sector push to rein in health costs, CVS has largely avoided the perils that have befallen its two primary rivals.
Even as Walgreen (WAG) and Rite Aid (RAD) have kept on ringing up cigarette sales, they've been setting off earnings alarms.
In August, Walgreen gave its chief financial officer the boot after the company had to slice $1.1 billion off prescription drug earnings projections for its 2016 fiscal year.
In mid-September, Rite Aid scaled back its earnings forecast for the current fiscal year.
In each case, downward pressure on reimbursements for prescriptions was behind the lower guidance.
The big picture is that health care is moving to a narrow-network world. As the government, employers and individuals seek to hold down health costs, pharmacies — just like physicians and hospitals — are being asked to accept lower reimbursements in return for more patient volume.
A prime example of this climate is the news that Medicare Part D monthly premiums will drop an average 2.3% next year, from $39.88 to $38.95, according to an analysis by consultancy Avalere Health.
A big part of the reason is that retail pharmacies are apparently bidding aggressively for preferred network status on drug plans, which offer special incentives to customers who buy from preferred providers.
"In an attempt to get an advantage, Walgreen appears to have taken on some reimbursement price risk and is getting squeezed," said Adam Fein, president of Pembroke Consulting.
A Sept. 22 downgrade from Barclays Capital analysts suggested that Walgreen had agreed "to accept a major step-down in reimbursement" of $1.30 per script to hold onto a large Part D preferred contract. Barclays analysts speculated that Wal-Mart Stores (WMT) may also have competed aggressively for the business.
Evolving Business Models
For retail pharmacies, prescriptions represent about two-thirds of revenue, with front-end retail making up the rest.
As the pressure on reimbursements persists, the industry is grappling with how to position itself for growth in the changing world of health care.
On the Sept. 18 earnings conference call, Rite Aid CEO John Standley said he thought the retail prescription model is becoming one in which their value isn't filling a generic prescription for a dollar less ($24 vs. $25), but in doing things like providing counseling and making sure that patients adhere to their dosing regimen.
"I think the model migrates (over the longer-term) to something more where maybe there is a reimbursement for the service that you are providing to the patient versus trying to make gross margin on the script," he said.
As Rite Aid and Walgreen enact their strategies for staying out front of these forces buffeting their industry, only CVS has stayed on an even keel.
The company's decision to quit selling cigarettes and take a big hit to revenue, albeit a revenue stream that was bound to gradually wane, reflects its enviable positioning for riding a big health-care wave of the future.
"They are the dead center of the health and wellness trend," said Wolfe Research analyst Scott Mushkin.
The move that set CVS on its current course was the $26.5 billion 2007 acquisition of prescription benefit manager Caremark.
That's around the time when CVS management settled upon an organizing principle that has guided their strategy ever since, Mushkin recalled: "We can't be in the way of reducing costs; we've got to be part of the solution rather than part of the problem.
A prime example of the way that CVS and Caremark combined to fulfill that mission is the company's Maintenance Choice offering, which provides for a lower per-pill cost for a 90-day supply, instead of the regular 30 days. It also improves the odds the patients will follow their dosing regimen.
The program makes sense for CVS because it doesn't only take a cut of prescriptions — and a smaller cut of 90-day prescriptions — but it is a pharmacy benefit manager which competes for business by providing value to employers.
Walgreen eventually had to match the CVS 90-day prescription program because of its popularity with customers, but that has been among the factors putting downward pressure on reimbursements, Barclays wrote.
As an added bonus, CVS has been able to count on its Caremark arm "to drive traffic into retail stores," allowing it to be less aggressive in bidding for preferred network status, Fein said.
While Caremark makes CVS less vulnerable to reimbursement pressures, Walgreen has had a complicated relationship with pharmacy benefit managers.
A falling out with Express Scripts resulted in lost retail business for Walgreen in 2012, as Express Scripts steered plan members to alternative pharmacies nearby.
Because the strong professional code of pharmacists is a given, "the actual dispensing of drugs is a commodity activity," said Fein, writer of the blog Drug Channels.
Still, Walgreen in recent years has been most focused on expanding its dispensing reach, most notably through the acquisitions of Duane Reade in the U.S. and Alliance Boots in Europe.
In June, CVS completed its $2.1 billion acquisition of Coram, a provider of specialty infusion services, which involves dispensing medicines through needles or a catheter into veins. Infusions can be provided at a patient's home or in a doctor's office or clinic, cheaper than via hospitals. The purchase is another example of CVS enhancing its value in a way that doesn't necessarily drive retail traffic.
Yet CVS also has raced to the head of the pack in building in-store clinics. It now has 900 MinuteClinics, about twice as many as Walgreen. It's on track to open 150 this year.
This is an area of promise as ObamaCare's insurance expansion, mainly via Medicaid, will crowd doctor's offices and spur the need for a convenient spot to get flu shots, strep tests and other straightforward services — some of which won't require any out of pocket payment for customers.
Revenues derived from MinuteClinic services rose 24% from a year ago in the second quarter.
Staffed by nurse practitioners and physician assistants, the MinuteClinics also provide health-condition monitoring for patients with chronic illnesses. This is of particular value to hospitals for whom re-admissions negatively impact both reputation and reimbursement.
CVS recently announced that it will link its electronic records with three additional hospital systems to facilitate care of their patients, bringing the total to 44.