Is it the single payer narrative being pushed by Democratic Presidential frontrunners? Is it the Amazon threat via its acquisitions of PillPack and Whole Foods that may displace traditional pharmacies? Is it the drug pricing pressures that are eroding margins and limiting margin expansion over time? Is it the secular decline in the physical footprint storefront retail space that’s hindering foot traffic and off-the-shelf purchases? Regardless of whether or not it’s singularly attributable to one of these factors or the culmination of all the aforementioned factors, CVS Health (CVS) and Walgreens Boots Alliance (WBA) are being pressured in many different directions. CVS and Walgreens have plummeted by 53% ($113 to $53) and 46% ($97 to $52), respectively from their multi-year highs. Over $110 billion in combined market capitalization has been erased from these two companies. With threats coming from all angles, will these two pharmaceutical supply chain heavyweights be able to not only survive but compete and revive their dominance in the marketplace?
Backdrop and Market Dynamics
The pharmaceutical supply chain cohort, specifically CVS and Walgreens, are simply unable to obtain firm footing in the backdrop of consolidation within the sector, negative legislative undertones, drug pricing pressures, rising insurance costs and a market that has lost patience with these stocks. All of these factors culminate into sub-par growth with a level of uncertainty as this sector continues to face headwinds from multiple directions. Many of the stocks that comprised this cohort presented compelling valuations in a very frothy market. This allure has been a value trap as these stocks continue to be a falling knife. It’s no secret that these companies have been faced with several headwinds that have negatively impacted the growth and the changing marketplace conditions have plagued these stocks.
The political backdrop has been a major headwind for the entire pharmaceutical supply chain (i.e., drug manufacturers, pharmaceutical wholesalers, and pharmacies/pharmacy benefit managers). Exacerbating the political climate, the drug pricing debate continues to rage on throughout political and social media circles weighing on the sector. This backdrop erodes pricing power and margins of drugs that ultimately move from drug manufacturers to patients with insurers and other middlemen playing roles in the supply chain web. In an effort to address these headwinds and restore growth, companies have made bold moves such as CVS acquiring Aetna (AET) to form one of the largest healthcare companies. Making bold acquisitions to restore growth may be the most viable means to heed competitive threats (i.e., Amazon with Pill Pack) and fend off headwinds. CVS will play an instrumental role in the future of healthcare and will have a growth platform in front of the company as healthcare spending continues to rise. Regardless, until growth is restored at CVS with Aneta being fully integrated to yield a fully functional bumper-to-bumper healthcare colossus, the stock will remain range bound.
Amazon Lawsuits Flying
CVS is transitioning and realigning its business to adapt to the changing healthcare landscape, such as Amazon’s nascent competitive threat. The PillPack acquisition was the biggest statement yet from Amazon that it intends to enter into this market.
Figure 1 – Adopted from Kyle Walsh / CNBC CVS / PillPack Lawsuit
Despite this stance that CVS and Walgreens are ostensibly not afraid of Amazon via various commentary from their CEOs and comparable offerings from each company. Walgreens CEO has been remiss and dismissive of Amazon since its inception into the healthcare space:
Walgreens CEO Stefano Pessina stated in 2017, “I honestly don’t believe that Amazon will be interested shortly in the next few years in this market,”
However, CVS is attempting to meet Amazon head-on and now offers one- and two-day delivery to all of its retail pharmacy customers nationwide and extended its same-day delivery to more cities. CVS already offers similar services and issued a statement.
Per CVS, “We already have the capabilities that PillPack is offering, and we have a scale in the business. Keep in mind that we have not seen a large shift of patients that are looking for their medications to be delivered versus coming to a retail pharmacy. And for those patients that do desire to transition, we offer the option to ship their prescriptions to their home from our pharmacies or obtain the prescriptions through our Caremark mail facilities,” “I think we have a lot of capabilities and a value proposition that can compete effectively in the market.”
Now lawsuits are being filed on non-compete grounds as CVS feels its PBM (pharmacy benefit management) business may be threatened by PillPack’s poaching of talent across the industry. CVS recently filed a lawsuit against John Lavin, a former senior vice president in charge of CVS Caremark’s retail pharmacy network, after Lavin left to take a job at PillPack.
CVS worries that Amazon is hiring Lavin to approach its CVS’ clients (i.e., insurance plans) that could undermine its lucrative PBM business. PBMs, help insurance companies negotiate lower drug costs. Manufacturers arrange discounts with the benefits managers so they can fix a spot for their products on a PBM’s list of preferred drugs. CVS’ PBM business represented approximately 60% of its overall revenues in 2018, equating to ~$116 billion.
The judge ruled in CVS’ favor, preventing Lavin from taking immediate employment at PillPack and granted CVS’ motion to enforce the non-compete agreement and block Lavin from working for PillPack for 18 months.
“Given its robust infrastructure, operational capacity, and distribution reach, Amazon-PillPack is uniquely positioned to negotiate directly with payers (insurers) and displace CVS Caremark’s mail-based services,” CVS argued for a preliminary injunction.
Judge John J. McConnell wrote, “Mr. Lavin will also negotiate and build relationships with private Payers and public Payers, both of whom are current CVS clients.” McConnell wrote, “It also appears that PillPack will be looking to negotiate directly with the insurers and others on the Payer level.”
CVS and Aetna Combination
To further boost long-term growth prospects, restore growth, and fend off potential competition, CVS acquired Aetna. This creates the first through-in-through healthcare company, combining CVS's pharmacies and PBM platform with Aetna's insurance business. The new CVS will combine its existing pharmacy benefits manager (PBM) and retail pharmacies with the second largest diversified healthcare company. This is a bold and hefty price tag to pay yet may be necessary to compete in the increasingly competitive healthcare space, changing marketplace conditions, and political backdrop with drug pricing pressures. CVS is making a defensive yet necessary acquisition before it can go back on the offensive moving into the future. The acquisition will provide CVS with more scale to negotiate for better prices for the prescription drugs it sells through its PBM business.
With the upcoming enterprise synergies via the Aetna combination, the newly formed CVS will be able to unlock value and growth long-term. This value creation will come through medical cost savings, membership expansion, customer retention, expanded customer value, and partnerships.
Both CVS and Walgreens have been value traps despite their P/E ratios indicating value as they both have strong balance sheets and growing dividends. Despite this solid backdrop, these value metrics are irrelevant until the companies can get a handle on the long-term growth picture. Healthcare spending is slated to grow, and with further consolidation with Aetna leading to cost efficiencies, pricing power, scale, and overall enterprise growth, CVS should be able to unlock value and growth. Until these companies can set the narrative and prove that they can adapt more quickly to the changing healthcare dynamics, these stocks will likely trade range bound, absent of any unforeseen catalyst.
The pharmaceutical supply chain cohort, specifically CVS and Walgreens, are simply unable to obtain firm footing in the backdrop of consolidation within the sector, negative legislative undertones, drug pricing pressures, rising insurance costs and a market that has lost patience with these stocks. Additionally, the single payer narrative, Amazon’s threat via its acquisition of PillPack, drug pricing pressures that are eroding margins and margin expansion and a secular decline in the retail space is exacerbating the situation for these companies.
All of these factors culminate into sub-par growth with a level of uncertainty as this sector continues to face headwinds from multiple directions. Many of the stocks that comprised this cohort presented compelling valuations in a very frothy market. This allure has been a value trap as these stocks continue to be a falling knife. It’s no secret that these companies have been faced with several headwinds that have negatively impacted the growth and the changing marketplace conditions have plagued these stocks. CVS is making a necessary yet defensive move with the acquisition of Aetna to grow its business long-term while expanding its moat to fend off competition. This combined entity will result in medical cost savings, membership expansion, customer retention, expanded customer value, and partnerships to drive growth and value creation. Enterprise synergies over time should unlock bottom line cost efficiencies to augment these areas.
Disclosure: The author does hold shares of CVS and may engage in options trading in any of the underlying securities mentioned. The author has no business relationship with any companies mentioned in this article. He is not a professional financial advisor or tax professional. This article reflects his own opinions. This article is not intended to be a recommendation to buy or sell any stock or ETF mentioned. Kiedrowski is an individual investor who analyzes investment strategies and disseminates analyses. Kiedrowski encourages all investors to conduct their own research and due diligence prior to investing. Please feel free to comment and provide feedback, the author values all responses. The author is the founder of www.stockoptionsdad.com where options are a bet on where stocks won’t go, not where they will. Where high probability options trading for consistent income and risk mitigation thrives in both bull and bear markets. For more engaging, short duration options based content, visit stockoptionsdad’s YouTube channel.