Walgreen's (WAG) sales continued to decline for the fifth consecutive month after the disruptive discontinuation of Walgreen's contract with pharmacy benefits manager Express Scripts (ESRX) this year. Express accounted for more than 12.7% of Walgreen's business in May 2011, and its exit helped to send same-store sales down by 5.8% in May 2012.

Walgreen walked out of Express Scripts' network last year over a reimbursement-rate dispute. Walgreen's dispute with Express Scripts and its prescription business exodus has significantly benefited its rivals, particularly CVS Caremark (CVS) and Rite Aid (RAD).

Walgreen and Express Scripts have recently dropped the legal claims filed against each other in September, fueling market expectations that there might be a reconciliation between the estranged companies. However, Walgreen has denied any connection between the withdrawal of legal claims and the possibility of a new contract.

Walgreen's sales continue to suffer

Walgreen's May sales decreased by 1.6% compared to May 2011 on reduced pharmacy sales, which were partly offset by the opening of seven new stores and the acquisition of 28 Bioscrip community pharmacies.

As a result, prescriptions filled at its comparable stores declined by 8.5%, leading to 4% lower pharmacy sales. Comparable-store pharmacy sales also were negatively affected by 4 percentage points because of generic drug introductions. Prescriptions processed by Express Scripts composed 12.7% of Walgreen prescriptions in May 2011 and contributed to a 10.8 percentage point decline in comparable-store prescriptions. Decreased footfall due to Express' exit also moderated front-end sales. Overall, 3Q sales for fiscal 2012 were 3.3% lower compared to the same period last year, with 6.5% lower comparable store sales and 9% fewer prescriptions.

Walgreen's biggest competitors, CVS Caremark and Rite Aid, have significantly benefited from the fallout last quarter gaining millions of new prescriptions as Express members looked for non-Walgreen pharmacies to fill their prescriptions, and ended up at CVS or Rite Aid stores. In particular, CVS has raised its full-year guidance, and is trying to make the new customers permanent,  taking advantage of the delays in hammering out a new deal. CVS could tap up to 20 million transferred prescriptions if the impasse continues through 2012.

Recently another large PBM Medco folded into Express Scripts, creating the industry's largest pharmacy benefits manager, which has raised concerns about the future of Walgreen's business with Medco, even though both expect to honor the existing contracts. Walgreen has recently renewed a pharmacy-services deal with another major PBM partner, UnitedHealth's OptumRx with a "long-term" agreement.

We value Walgreen with a $35 Trefis price estimate of its stock, 10% ahead of the current market price.