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WAL-MART’S SLASHED DRUG PRICES TRIGGER MEDIA FRENZY

By Rodger Brown

The local pharmacist is used to advising customers about the risks associated with certain medications — allergic reactions or other side effects. Sometimes drugstore chains and those who invest in them experience serious risk of another sort: the risk associated with certain press releases.

Analysts call it “headline risk,” the chance one takes when investing in a company whose shares are about to get caught in frenzy of media speculation, and not in a good way. That happened in September, when Wal-Mart announced a test in the Tampa, Fla., area whereby it would cut the price on a handful of generic drugs to $4 for a one-month supply. The top three chains — CVS, Rite Aid and Walgreens — shrugged it off, pointing out that the nearly 300 drugs on Wal-Mart’s discount list were older generics that were nearly that cheap already for most insured patients.

From a revenue perspective, the announcement should have had little impact. One analyst at Barrington Research wrote, “To me the whole issue is more of a headline risk than a real risk to the pharmacy business.”

But overnight, headline risk became headline wreck, and analysts and commentators had a field day. “Drug Stores Plunge,” trumpeted AFX News, an international financial news service. One screamer on Yahoo Finance blared: “Wal-Mart’s Prescription Drug Plan Could Impact Entire U.S. Health Care System.”

Investors panicked. CVS fell 8 percent, Walgreens dropped 7 percent and Rite Aid slid 5 percent. Even discount chain Fred’s felt the sting, plunging 9.8 percent despite the fact that it has no stores with pharmacies in Florida.

The assumption on the street seemed to be that Wal-Mart’s drug plan (which the company has since rolled out in 26 other states, well ahead of the original schedule) would spark a pricing war. The conventional wisdom reasonably concluded that Wal-Mart would do to drugstores what it has done to retailers in other sectors. A commentator on the market-watching Web site SeekingAlpha.com concluded, “Wal-Mart crushed many of the inefficient or simply ‘less efficient’ supermarkets when they moved into food retailing — I would expect they could have a similar impact here.” Even an analyst at Bear Stearns wrote that the move was another assault by Wal-Mart on a retail sector that had “outsized margins.”

But there were dissenters. John Heinbockel, a Goldman Sachs analyst who covers food and staples retailing, called it a “nonevent” in a note to his clients. “We strongly believe that Wal-Mart’s strategy sounds worse than it really is,” Heinbockel wrote. Derek Leckow, an investment analyst with the investment banking firm Barrington Research wrote: “People are looking at this as a potential shift in the industry as it was when Wal-Mart entered other industries. The difference is that Wal-Mart is not entering a marketplace with very fat margins, waste and lots of inefficiencies. You have a very highly efficient business model that these drugstore companies have perfected, and Wal-Mart’s price differential is not very big.”

According to the National Association of Chain Drug Stores, a generic drug prescription costs $28.74 a month, on average. Customers with co-payment plans see that reduced significantly, often below even Wal-Mart’s $4, says Deutsche Bank’s William Dreher, an analyst covering the broadline retail sector that includes Wal-Mart. Dreher says that even if CVS and Walgreens were to match the prices on the Wal-Mart list, this would shave only about a third of 1 percent from CVS’s sales and half of 1 percent from Walgreens’. As well, other commentators suggest that customers in urban areas are unlikely to switch to Wal-Mart, because of its lack of presence there. The convenience of the drug chains in these places negates the value of a few dollars worth of savings urban dwellers could obtain by driving to an out-of-town Wal-Mart.

Others speculated (and Wal-Mart denied) that the cheap generics were being used as a loss leader to get people into Wal-Mart stores. Commentator Steven Smith wrote on TheStreet.com that saving a few dollars on already cheap drugs was little incentive for customers to change their buying habits. “The premise of using lower-priced generics to drive store traffic really shouldn’t pose too great a threat to CVS, Walgreen or even Rite Aid, which rely on their convenience to consumers,” he wrote.

William Sawyer, a pharmaceutical analyst at Leerink Swann, agreed, asserting that the plan would not create much price pressure, because the chosen drugs are already “heavily commoditized.” “Many have already seen significant price erosion,” he wrote, “so I don’t see this having a big impact right now.”

Merrill Lynch food and staples retail analyst Patricia Baker wrote that Wal-Mart’s initial announcement “caused an overreaction” that temporarily hurt CVS, Walgreens and Rite Aid. “We believe the impact to their operations will be much less significant than feared,” she concluded.

But if all that is true, then why all the hubbub in the first place? Well, it was that headline-risk thing.

Baker astutely signaled what was up when she noted that the dips in Walgreens and CVS share prices represented “an excellent buying opportunity,” but that “those wishing to avoid the headline risk in this particular issue” should look at investing in drug suppliers in Canada.

Wal-Mart’s move comes at a time when Americans are increasingly dissatisfied with and distrustful of the health care industry. In August a Wall Street Journal Online/Harris Interactive poll showed that 80 percent of Americans favor importing drugs from Canada if they are cheaper. And 84 percent agree that the laws banning drug imports are intended to protect the profits of drug manufacturers.

Combine that with the recent Medicare plan that increases drug coverage for senior citizens and with Wal-Mart’s ongoing battle against labor unions and consumer groups over wages and benefits and you have an extremely flammable mix in which the headline risk is greater than ever. The shares of the major chains rebounded after investors began to see things as one headline asserted: “Wal-Mart Drug Plan Less Than Meets the Eye.”

But the headline risk will remain as long as health care costs remain an issue. When the Wal-Mart plan was announced, Bill Simon, executive vice president of Wal-Mart’s professional services division, said in a press release that “for Americans who lack coverage or are struggling to the point that they can’t afford their medicines and then don’t get the health care they need, this program gives them options and access. … [T]his will help all of our customers and all of our associates from all walks of life.”

But the National Community Pharmacists Association, which represents nearly 25,000 independent pharmacies, blasted the plan as being faux humanitarianism. The group called it a “cynical attempt to gain maximum public relations value while providing minimal value to patients.” And Gary Claxton, vice president of the Henry J. Kaiser Family Foundation, said: “Generics are not very expensive in the first place. It’s a good thing to make generic drugs cheaper, but that isn’t where most of the big costs are.”

Though all agreed that the biggest benefit of the price discounts would accrue to the uninsured, who will now save a few dollars on generic prescriptions, one commentator speaking on National Public Radio questioned even that.

“I don’t think it will have a dramatic impact on health disparities, because, you know, one has to go to the doctor first,” said Dr. Gail Christopher, vice president of the Joint Center for Political and Economic Studies, a non-profit, Washington, D.C.-based organization that describes itself as the “nation’s only black think tank.” “And it’s the lack of insurance that keeps the person from going to the doctor to get the prescription.”