Confusing Stock Market Reaction

So, Walgreens announced that they were going to miss earnings because of generics (oh and higher expenses).   All of a sudden, the PBM stocks (e.g., Medco and Express Scripts) took a hit which makes no sense to me.  [BTW – I own none of these individual stocks although they may be in mutual funds that I own.]

Walgreen Co., one of the nation’s biggest drugstore chain operators, said Monday its fourth-quarter profit dropped nearly 4 percent because of lower reimbursements for some popular generic drugs and increased store and staff costs.  (See all)

“If Walgreen is receiving lower reimbursement for some generics, it means that PBMs are paying the company less for generic drugs,” Wachovia analyst Matt Perry surmised on Tuesday. “In other words, the PBMs’ drug purchasing costs have gone down. We think the selloff in shares of Medco and Express Scripts is unwarranted.” (see entire article)

At least one analyst understood.  But, why would the market response this way.  There are only a few reasons that these could be correlated positively.  My hypothesis would have been that if Walgreens is getting less than the PBMs are making more or are neutral.  This would make sense because if the PBMs paid Walgreens less they wouldn’t immediately pass that on to their clients assuming they make spread on those claims and have multi-year contracts with employers and managed care companies.  And, if they simply passed on the retail costs to their clients, it would have no impact on them.

How could it be true that Walgreens and the PBMs made less?

  1. The acquisition cost of generics could have gone up which would likely only happen if the wholesalers (e.g., McKesson or Cardinal) changed their prices dramatically or the generic manufacturers increased their prices (not likely).
  2. A significant number of PBM clients (or major managed care companies with their own PBMs like Aetna, Cigna, Wellpoint, Humana) requested price concessions on generics which forced the reimbursement rates down for the retail pharmacies and the mail order pharmacies.  (possible, but clearly not what you hear from the other players)
  3. Costs for a specific generic (with material marketshare) changed dramatically from what was forecasted (shame on the planner).  The worse case here would be if they struck a sweetheart deal (i.e., guaranteed supply at a lower than market price) and then saw the price drop out with a new manufacturer come to the table.

Generics are definitely a key profit driver for the pharmacy industry.  The average AWP (average wholesale price) is $40 (for a 30-day supply).  Companies pay less than 50% of this.  The actual costs are typically less than 80%.  And cash customers pay greater than 100%.  Lots of spread.

Now, of course, there are costs to fill each prescription so it is not that simple.

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