Good Times Ahead for Major Drugstore Chains
By George Anderson
A large population in need of medications to address the numerous health issues that come along with advanced age is just one reason the two largest U.S. drugstore chains have reason for optimism.
Another is the higher margins that come with selling higher profit generic versions of the name brand drugs once their patents have expired.
Both Walgreen and CVS have posted impressive operating results for many years.
Walgreen, which has focused on growing primarily through organic measures, has had 31 straight years of increasing sales and profits.
CVS, which has focused more on acquisitions than its larger rival, has developed a reputation for buying stores and making them more profitable than they had been under previous ownership.
According to a report in The Wall Street Journal, analysts expect profits at the two chains to grow 14 percent (CVS) and 15 percent (Walgreen) over the next five years.
Moderator’s Comment: What do you see as the respective strengths of Walgreen and CVS? –
George Anderson – Moderator
Walgreens has always followed a strong, conservative approach to growth that has served them well. They are aggressive in their core areas, such as Chicago, in building new locations and replacing old ones. It has been interesting to watch CVS enter the Chicago market and go head-to-head with Walgreens. They too have been aggressive in their site selections and seem to have competed very effectively with Walgreens. I would like to know how the share numbers have changed as a result of all this activity.
Based on observing these two chains in this area, they both seem to have good legs that will carry them a long way. If I had to choose which I thought would be the most successful, I would have to favor Walgreens.
With a graying population which is increasing every year, and the prescription drug coverage of Medicare just enacted, we can count on an increased growth in drug needs for our population. This means that drug stores like CVS, Walgreens and others should continue to see increased growth as their total markets grow, even if their share of market stays the same or only increases slightly. This will also bode well for their profits, store growth and retail presence as they seek to exercise their strengths in other areas. Food, more hardlines and, of course, acquisitions would all be natural positions for these chains as they seek to better allocate their resources in the future.
In general, I’d say that Drug Stores are in need of an overhaul, from a planning and visual standpoint. Considering an aging customer base, what have most of these stores done to improve access, install more legible signage, or provide product that the baby boomer may want in their senior years? Also, as I stated before, in the inner city when big box discounters don’t often fit, the drug store chains act like a small Wal-Mart or Target. When will the discounter figure this out and come a’hunting for this real estate?
I agree that prescriptions drive profits at the top drug chains. But Walgreens and CVS are investing in real estate portfolios that may help insulate them against changes in the reimbursement status quo.
Both chains have brought sophisticated and customer-friendly prescription refill systems to market that integrate in-store, online, telephone IVR, and mail-order services chain-wide. Clearly the goal is to keep customers loyal and reduce the costs associated with fill a prescription so that more drops to the bottom line.
It should cost no more to dole out a month’s worth of a $9 drug than a $90 drug. Pharmacies could make a go of it even if they earned a flat fee markup per prescription. As long as the patients keep coming back every month for refills, the stores will reap add-on sales from the variety and convenience merchandise in the front of the stores.
Both companies are profitable because of their prescription business. Prescription margins will be severely cut when the federal government, in its desperate search for medical cost reductions, starts managing drug reimbursements as aggressively as they now manage doctor reimbursements. The (formerly) strongest lobbying organization in the country, the American Medical Association, hasn’t been able to protect its members from having their fees cut drastically by Medicaid and Medicare over the years. There are many MD’s getting single-digit fees for procedures that used to cost double and triple digits. The Veteran’s Administration uses competitive bidding and aggressive price negotiation for its drug purchases. These tactics were banned by the recent Medicare drug law, but it won’t be long before the economic pain becomes so excruciating that the federal government will change its tune. Furthermore, the temptation to allow competitive low-priced foreign imports will grow and grow. Drug stores are riding high, and all will make money, until the government gravy train runs off the tracks. Then there will be hundreds of store closings.
The key question is what chain has the better balance sheet, and free cash available. I do know, given the annual report of Walgreen’s that it has 1 billion dollars in cash.
Both chains will do well; but Walgreen’s has a better shopper sales strategy, and new store strategy for
locations. Hmmmmmm
I agree with Jerry’s observation around the strength that these drug stores derive in the inner cities because of their smaller size. Walgreens already gives one the impression of a Wal-Mart (maybe it is the blue overcoats that their associates wear or is it the waiting time at check-out?). Of the two, I would back Walgreens due to various reasons – their strategy to focus on file buys, organic growth and IT innovation. (Their recent RFID implementation for measuring impact of displays is a good example.) All said and done, inorganic growth is not an easy game – Jean Coutu is already struggling. It will be interesting to see the impact of Medicare on the industry and possible sale of Savon and Osco stores by Albertsons. One thing that the industry in general needs to invest in is data analytics. Front end sales will be equally important for pure play drug retailers and it will be extremely critical for them to know who is buying what and at what time of the day (since they have 24 hours presence more than some one like Wal-Mart).