By Yagmur Kurt
Pharmacy stocks have been some of the best performers over the past two years, despite lower overall sales, due to an increase in newly available generics. For example, Costco Wholesale Corporation (NASDAQ:COST) is up 41%, CVS Caremark Corporation (NYSE:CVS) is up 57%, Express Scripts Holding Company (NASDAQ:ESRX) is up 10.8%, Rite Aid Corporation (NYSE:RAD) is up 191%, and Walgreen Company (NYSE:WAG) is up 15% over the last two years alone. Investors holding a basket of these retail pharmacies would have thus easily trumped the broader market with a stunning 62% return.
The increase in generics for blockbuster drugs coming off of patent protection has led to an odd situation in the pharmacy space. Specifically, revenues have generally been either flat or declining amongst retail pharmacies, yet profit margins are growing at a healthy rate. The sum effect is that pharmacies are becoming more profitable even as gross sales are declining. On June 6th, for example, Rite Aid announced that monthly pharmacy sales declined by 1.5% for the month of May, yet profitability continues to increase due to the wider margins inherent in generics. Even so, the increasing utilization of generic drugs is far from the only reason to remain bullish on drugstores.
The long-term outlook for drugstores looks particularly bright due to a number of factors, including an aging population in the U.S., an increasing number of more profitable generic drugs coming on the market, the continued development of innovative new drugs that become an integral part of people’s daily lives, and the expansion of health care insurance coverage under the Patient Protection and Affordable Care Act signed into law in 2010 (the ACA).
The massive expansion of health insurance to previously uninsured patients, in particular, is projected to be a major catalyst for pharmacies going forward. Drugstores like CVS and Walgreens have begun positioning themselves to take advantage of this event by opening so-called “drugstore clinics” that provide basic care for chronic illnesses like asthma, diabetes, and high cholesterol. CVS Caremark was the first drugstore to open mini-clinics in 2010 with their rapidly expanding “Minute Clinics” franchise, which is expected to top 1,700 locations by 2017. Walgreens quickly followed suit by opening their own clinics called “Take Care Clinics”, which already number 371 locations inside the U.S. (see the company’s recent 10-Q).
The business strategy behind the drugstore clinic is simple yet brilliant. The U.S. is experiencing a growing shortage of primary care physicians, but a rapidly increasing number of patients due to an increase in obesity and chronic diseases, coupled with an aging population. Moreover, the influx of newly-insured Americans only adds to the patient-to-physician imbalance.
Drugstore clinics aim to meet this need by using nurse practitioners and physician assistants to monitor chronic diseases, and by having longer hours than traditional doctor’s offices. As a result, patients won’t have to wait hours on end at a busy doctor’s office just have their blood drawn or vitals taken. An ancillary benefit of treating patients with chronic conditions is that this patient population will more than likely choose to bundle their shopping and healthcare needs. In effect, these patients will probably end up buying household products generally sold at retail pharmacies like CVS and Walgreens, thus fattening these companies’ bottom line.
While Take Care and Minute Clinics are fighting over patients suffering from chronic diseases like obesity and high blood pressure, Assured Pharmacy Inc. (OTCMKTS:APHY) has chosen to focus on patients suffering from pain. According to the Institute of Medicine, over 100 million Americans suffer from acute or chronic pain. Yet, this patient type frequently struggles to get the medicine needed due to the widespread abuse of prescription medications. In fact, new State and Federal laws aimed at curbing this epidemic have created significant legal hurdles and loads of paperwork that retail pharmacies like CVS and Walgreens are ill-equipped to handle. As such, chronic pain sufferers all-too-often wait for long periods to get their medications, and suffer needlessly in the meantime.
Assured Pharmacy is a new breed of drugstore specializing in pain management that seeks to relieve the administrative burdens of handling Class II drugs for patients and doctors alike. Assured’s staff is specifically trained to deal with drug security, the legal paperwork associated with pain meds and, most importantly, focuses on getting the correct medications to patients in a time-sensitive manner. In fact, Assured offers patients next-day home delivery for patients that are unable or unwilling to come to one of the company’s locations. While this company is certainly tiny in terms of market cap and is consequently a risky investment, Assured’s management has mapped out an aggressive business plan with the opening of new stores across the U.S. in hopes of capitalizing on this unmet medical need. Assured Pharmacy therefore offers investors an opportunity to get in on the ground floor of a healthcare company entering a wholly unmet medical need.
In sum, the ACA is generating intriguing investment opportunities in the drugstore sector, especially amongst chronic care providers. CVS Caremark and Walgreen Co. appear to be well-positioned to handle the influx of new patients suffering from chronic diseases with their drugstore clinic model, and specialty pharmacies like Assured that focus on administratively burdensome conditions like pain management should benefit as well. Overall, I think the ACA will be a major catalyst for the drugstore industry as a whole, but these three companies (APHY, CVS & WAG) have the biggest upsides in my opinion. To limit risk in this highly competitive space, I believe a basket approach that incorporates all three companies will reward investors in the long run, and protect them from unforeseen hurdles in the ever changing political landscape surrounding healthcare and prescription drugs.