BOSTON (TheStreet) -- The $223 billion drug-retailing industry has changed dramatically over the past decade as the expansion of national chains and their alliances with pharmacy-benefits managers has resulted in a landscape dominated by just three firms.
But there are significant challenges for these companies even though the long-term, overarching industry trends are highly positive and analysts are upbeat on their prospects.
On the upside, these companies' sheer size provide them greater leverage in negotiating prices with drug wholesalers, while national demographics favor growing demand for drugs as baby boomers lurch into their retirement years. Also, a rising number of annual patent expirations for brand-name drugs are starting to hit this year, which improves retailers' margins. Finally, consumers are increasingly accepting mail-order drug delivery, resulting in a low-cost component to companies' operations.But a wildcard to all that is whether the Supreme Court will approve the Obama administration's proposal that would force health-care insurance on the populace. If that's approved, it would serve to boost drug sales, but retailers would face more government scrutiny in administering those programs, which would put pressure on profits. The most recent industry-shaking event of late, the $29 billion merger of Express Scripts (ESRX - Get Report) with Medco Health Solutions (MHS) that closed April 2, results in a pharmacy-benefits manager powerhouse with nearly $100 billion in revenue and a 40% market share. Pharmacy-benefits managers are third-party managers of drug-prescription programs, most typically for health insurers. They have agreements with drug retailers to dispense the drugs for them so the retailers depend on them for significant business under lengthy contracts, and their increasing power is another factor retailers will have to contend with to protect earnings. 10 Stocks That Could Rise in Market Decline The biggest player in drug retailing is CVS Caremark (CVS - Get Report), and its size and industry dominance is due to its merger with pharmacy-benefits manager Caremark in 2007. It dispenses more than 1 billion prescriptions a year and had sales of $107 billion in 2011. It goes head-to-head with Walgreen (WAG), which is the nation's largest retail chain, in terms of stores, with about 8,000. Prescription drugs account for about two-thirds of its roughly $73 billion in annual sales. But it now faces a huge challenge due to the loss of its contract with Express Scripts at the end of 2011. That could hurt its results significantly, unless it can renegotiate. The loss of that relationship hurt second-quarter results by 7 cents per share, the company said in reporting earnings of 78 cents per share two weeks ago. "With a large percentage of CVS stores located within close proximity of a Walgreen location, we believe CVS will be the primary benefactor of a disruption in Walgreen's business," writes Joseph Agnese, an analyst for S&P Capital IQ. In third place among drug retailers is Rite Aid (RAD - Get Report), with about 4,700 stores nationally. It gets about 68% of its roughly $25 billion in annual sales from prescriptions. It has posted losses since its 2007 acquisition of the Brooks and Eckerd store chains due to the debt it took on to make the deals, followed by the recession. Standard & Poor's analysts said in a March 13 research note that the "national chains are well positioned as their pharmacy departments continue to gain in importance, with prescription sales increasing in the low single digits on a comparable-store basis and approaching 70% of total sales." 12 Highest-Rated Consumer Stocks Picked by S&P The drug-dispensing part of the business also provides a magnet for consumers that results in a sustained relationship and sales of other goods with each visit. According to the National Association of Chain Drug Stores, the average distance to the nearest pharmacy is 1.6 miles, which makes pharmacies among the most convenient sources of health-care goods, basic consumer items and increasingly, food products, which can provide higher-margin sales than some drugs. Here are summaries of the nation's three leading drug retail chains ranked in inverse order of "buy" ratings:
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