First a primer on the pharmacy business. On one side you have hundreds of drug manufactures and on the other you have hundreds of pharmacy benefits managers (PBM). Rite Aid, like Walgreens sit between the two and negotiate wholesales prices with the manufactures to buy drugs at the cheapest price possible and then negotiate with the PBMs to sell those drugs at maximum profit to their members. For example, on a pill valued at $20 that Rite Aid is purchasing for $18, they would charge the customer $5 and expect a $15 reimbursement from the PBMs which leaves Rite Aid a $2 profit. In our current economic environment, both PBMs and drug manufactures are pricing more competitively which is shrinking the pharmacy's margins.
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| Remodeled Rite Aid Beverly Hills |
The transition to using McKesson, a global wholesale drug distributor, was presented to investors as a way to increase profits by utilizing their larger scale to negotiate prices better than Rite Aid could by itself. While this is helping, PBMs are still reimbursing less so it's a wash. In the latest conference call management now attributed the low earnings to less generics and lower reimbursements. Basically McKesson is just keeping Rite Aid afloat and it will require outside revenue to spur growth which is expected to come from the expansion of RediClinic and Wellness stores, however at this point investors are sick of waiting and annoyed with management.
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| Remodeled Rite Aid Beverly Hills |
As an investor this position has turned from a spec into a long because Rite Aid has lost their tailwind. Now we need to focus on the ROI of their RediClinic and Wellness store remodels since we should assume profits from drug pricing will erode as the industry becomes more efficient.
To quote CEO John Standley, "But I think over time there is only so many dollars we are going to be able to squeeze out of the drug spends, particularly on the generic side. And so, it's really going to come down to then what differentiates you in the marketplace....So at some point, I think the model migrates to something more where maybe there is a reimbursement for the service that you are providing to the patient versus trying to make gross margin on the script. Is that going to happen tomorrow, it's not. But I think if we look over the longer-term, that's really probably the model that our industry needs to begin the migration to over some period of time."I expect the stock to continue to drop for at least two more quarters where I may try to reduce my cost basis but a return to over $8 is out of reach as of now.
