Walgreens, CVS, and Rite Aid - What RE Investors Should Know in 2011
Walgreens, CVS or Rite-Aid: Which Tenant Is Best in 2011?
Walgreens, CVS, and Rite Aid - What RE Investors Should Know in 2011
Walgreens, CVS, and Rite Aid - What RE Investors Should Know in 2011
Walgreens, CVS, and Rite Aid - What RE Investors Should Know in 2011
Walgreens, CVS, and Rite Aid - What RE Investors Should Know in 2011
There are 3 major drugstore chains in the US: Walgreens, CVS, and Rite Aid. Below are some key statistics about the 3 major drugstore chains as of July 2010:
Walgreens ranks #1 with market cap of .33 Billion, .25 Billion in revenue, and S&P rating of A+. According to Walgreens, 75% US population lives within 3 miles from its stores. On Oct 1, 2009, Walgreens opened its 7000-th store in Brooklyn, New York. In April 2010, it acquired 258 Duane Reade drug stores in New York Metropolitan area. CVS ranks #2 with market cap of .09 Billion, .1 Billion in revenue (CVS revenue alone is less than Walgreens if revenue from its Caremark group is taken out), and S&P rating of BBB+. CVS opened its 7000-th store in Little Canada, Minnesota on October 5, 2009 and currently operates 7025 drug stores ... Rite Aid ranks # 3 with market cap of $ 25.53 Million, 9 Billion in revenue, 4780 drug stores and rating of B-S&P.
Investors purchase properties occupied by these drugstore chains for the following reasons:
The drugstore business is recession-insensitive. People need medicine when they are sick, regardless of the state of the economy. Both rich and poor people in the u.s. have access to medicine. Some even argue that low-income people use more medicine due to free or low-cost drugs offered by governMent-assisted programs. So the tenants should do well during tough time and have money to pay rent to landlords. The drugstore business has a goodprospect in the US: People are living longer and need more medicine to sustain longevity, e.g. Actonel for osteoporosis, Aricept for Alzheimer's symptoms. Older people tend to use more medicine than younger ones as they often have more medical problems. As the 78 million baby boomers are getting closer to retiring age starting from 2008, the drugstore chains anticipate the demand for medicine to increase in next 20 years. The drug market continues to expand as the US population will continue to grow. More and more Americans suffer from various diseases. The number of Americans suffers from seasonal allergies doubled in the last 15 years to 37 million people per Fortune magazine. They spent .4 Billion in 2009 for allergy drugs. As their waist lines balloon (75% of Americans are forecasted to be either overweight or obese by 2020), more Americans are diagnosed with diabetes, high cholesterol at younger and younger ages. In addition, doctors also recomMend treating various diseases sooner than later due to better understanding about the diseases. For example, doctors now prescribe anTiretroviral drugs for patients soon after infected with HIV virus instead of waiting for the infection to become AIDS. More doctors combine insulin with oral medicines to treat type-2 Diabetes instead of just oral medicines alone. All these factors increase the size of the drug market. Advance in genetic engineering has introduced various new genetic DNA testing kits which allow the genetic diagnosis of vulnerabilities to inherited diseases and disorders. Genetic testing is currently the highest growth segment in the diagnostics industry. Some of these genetic tests will probably transform into direct-to-consumer testing kits available in drug stores in the near future. Upon FDA approval, these new products will potentially bring in additional revenue for drug stores. The passage of Health Care Reform Bill on March 23, 2010 provides insurance coverage to an estimated 33 million more American. This is a major present to the drugstore industry. There are new drugs to treat previously untreatable illnesses, and new diseases, e.g. Viagra for men's unhappiness, Zoloft for depression, Avastin for colon cancer, Herceptin for breast cancer, Nicotine patches for smokers to kick the habit, Tamiflu for a potential bird flu pandemic, vaccine for swine (H1N1) flu pandemic, Tekturna/Rasilez for hypertension and various new drugs for AIDS and Attention Deficit Disorder (ADD). The new medicines are very expensive, e.g. a year's Supply of Avastin costs about ,000. Eli Lilly has sold about $ 4.8 billion of Zyprexa in 2007 for schizophrenia and yet most people have never heard of this medicine. There are existing drugs now approved to treat new illnesses and thus increase their sales revenue. For example, Lyrica was originally intended to treat pain caused by nerve damage in people with diabetes. It is now approved by FDA to treat Fibromyalgia which affects 5.8 million Americans to WebMD. Big advances in genetics, biology and stem cells research are expected to produce a new class of drugs to treat diabetes, Parkinson's and various rare genetic disorders.For example the new drug from Novartis Ilaris targets genetic causes of an inherited disorder that there are only 7000 known cases worldwide. However, Novartis hopes to gradually broaden its drugs to a blockbuster drug to more common disorders caused by similar genetics. Technology and modern life introduces and require new products, e.g. pregNancy test kits, Lamisil for toe nails stronger, clearer Latisse for longer thicker eyelashes & for menopausal symptoms, Premarin, diabetic monitors, electronic toothbrushes, contact lenses, lenses cleaners, diet pills, vitamins, birth-control pills, IUDs, nutrition supplements and Cholesterol-lowering pills (Americans spent nearly $ 26B in 2006 on Cholesterol medications alone for IMS Health, a Connecticut-based consulting company that monitorspharmaceutical sales.) There are also more surgeries: C-sections, Kidney transplants, open-heart triple by-pass, and breast augmentations. More surgeries mean more medicines are needed such as Vicodin for pain management and Warfarin to prevent blood clots in surgeries. Before the customers can get to the medicine aisles or pharmacy counters, they have to pass by chocolates, sodas, digital cameras, Watches, toys, Dolls, beers and wines, cosmetics, video games, flowers, fragrances, and greeting cards. Drug stores hope you use the one-hour photos services and exchange your liquid propane tanks there. The stores also carry seasonal items, e.g. Halloween costumes, and "As Seen on TV" merchandise, e.g. Shamwow. As a result, customers buy more than their prescriptions and medicine in these drugstores. Rite Aid sells more non-28.000 pharmacy items in its stores while Walgreens has 22.000 different items on store shelves. CVS reported that non-pharmacy sales represented 30% of the company's total sales in January of 2007. The figures for Walgreens is 34% and 37% for Rite Aid. Many pharmacy locations are in effect convenience stores especially ones that are in residential or rural areas. And I know Walgreens hopes that customers also pick up WD-44, and screw drivers at its stores instead of at Home Depot; Thai Jasmine rice, and Fish sauce to avoid a trip to Safeway or Kroger Supermarkets. During the recession, sales of these non-drug items are down as customers buy what they need and not what they want. Walgreens tries to reduce the number of items by 4000.It also introduces its own private label which has higher profit margins. There are more and more generic medications on the market as a number of enormously popular brand-name blockbusters will lose their 20-year long patents, e.g. Lipitor (best selling drug in the world to lower cholesterol) in 2010, Viagra (you know what it's for) in 2012. Drugstores prefer to sell generic drugs to customers due to higher profit margins than the brand-name medications. Some people are addicted to pain killers, e.g. Hydrocodone and consume a large amount of medicine, e.g. 30-day dosage in a day to get high. According to testimony from the National Institute on Drug Abuse, US retail pharmacies dispensed nearly 180 million prescriptions in 2007 for opiates ", e.g. Hydrocodone. A high percenTAGe of theseprescriptions are probably not used for any legitimate medical purposes. This author estimates that at least 10% of the dispensed prescription drugs are not used at all and sit idle in the medicine cabinets. They are eventually expired and thrown away. These companies sign very long-term, NNN leases, guaranteed by their corporate assets. This makes the investment in the underlying property fAirly low risk, especially for Walgreens with an A+ S&P rating. In fact, these properties are sometimes referred to as investment-grade properties. Once the drugstore chains sign the lease, they pay the rent promptly and timely. This author is not aware of any properties leased by one of these drugstore chains in which the tenants failed to pay rents. Even when the stores are closed due to weak sales (Walgreens closed 119 stores in 2007), these companies may sublease the properties to other companies and continue to pay rents on the master leases. A typical Walgreens lease consists of 20-25 year primary term plus 8-10 five-year options. During primary term and options, there will be no rent increases in most of the leases. This is the main disadvanTAGe of investing in Walgreens drugstores. A typical CVS lease consists of 20-25 year primary term plus 4-5 five-year options. The rent is normally flat during the primary term and then there is a 2.5%-10% rent increase in the in each 5-year option. A typical Rite Aid lease consists of 20-25 year primary term plus 4-8 five-year options. The lease often has a rent increase every 5-10 years.
Investment Risks: Although the pharmacy business in general is recession-insensitive, there are risks involved in your investment:
The main downside about investing in pharmacies is there is little or no rent bump for a long time, e.g. 20-50 years, especially for Walgreens. I know the rent is effectively reduced after inflation is factored in. This is one of the main reasons these properties do not appeal to younger investors. The 3 drugstore chains now have a new formidable competitors, Wal-mart. Wal-mart sells prescription drugs in more than 4000 Wal-mart, Sam's Club and Neighborhood Market stores in 49 states. The retail giant is known for launching in 2006 to highly-publicized $ 4 generic prescription drug program which now sells 350 generic medications for a 30-day Supply. The actual numberof medications is less as the medications with different strengths are counted as different medications. For example, Metformin 500 mg, 850 mg, and 1000 mg are counted as 3 medications. Wal-mart probably makes very little profits on these medications if any. However, the marketing campaign--created by Bill Simon, the President and CEO of Wal-mart GE, generates a lot of publicity for Wal-mart. Wal-mart hopes to draw customers to its stores with other prescriptions where it has higher profit margins. In an unscientific survey with just one brand-name prescription of Lyrica, this author finds the lowest price at Costco, the highest price at Walgreens and Wal-mart at the middle. Other drug chains try to counter Wal-mart in different ways. Target now offers the same 350 generic medicationsfor for a 30-day supply. Walgreens has a Prescription drugs club with membership fee which offers 1400 generic medications for as little as /week. CVS says it will match any offers from its competitors. Chief Business Correspondent Rick Newman from US World & News Report predicted that Rite Aid might not survive in 2009. While Rite Aid is still around in 2010, dire predictions continue. The study by Audit Integrity gave Rite Aid about a 10.5 percent chance of filing for bankruptcy in 2010. Drugs are also sold in thousands of supermarkets, Target stores, and Costco warehouses. However, there are no drive-through windows at these stores or Walmart to conveniently drop off the prescriptions and pick up medicines. Customers will not be able to pick up their prescriptions during lunch hour or after 7:0 pm at Target stores or supermarkets. They need to have membership to buy medicines at Costco. Others may not fill their prescriptions at Walmart because they don't want to mingle with typical Walmart customers who are in the lower income brackets. And some babyboomers don't want their prescriptions filled at Target or Walmart because there are no comfortable chAirs for them to sit down to wait for their medicines. Many leases in areas with hurricanes and tornados are NNN leases with the exception of roof and structure. So if the roof is damaged, you will have to pay for the expenses. The tenant may move to a new location down the road or across the street when the lease expires. This risk is high when the property is located in the small town where there is low barrier forentry, i.e. lots of vacant land you want &. The tenant may ask for rent concession to improve its bottom line. The possibility is higher if the tenant is Rite Aid and if the store has low sales revenue and/or higher than market rent. More Americans are walking away from their prescriptions, especially the most expensive brand-name medicines. This may have negative impact on the sales revenue and profits of drug stores and consequently may cause drug store closures. According to Wolters Kluwer Pharma Solutions, health-care data company, nearly 1 in 10 new prescriptions for brand-name drugs were abandoned by people with commercial health plans in 2010. This is up 88% compared to 4 years ago just before the recession began. This trend is driven in part by higher and higher co-paysfor brand name drugs as employers are shifting more insurance costs to their employees.
Among 3 drugstore chains, Walgreens and CVS pharmacies in general have the best locations-at major intersections while Rite Aid has less than premium locations. Walgreens tends to hire only the top graduates from pharmacy schools while Rite Aid settles with bottom graduates to save costs. When possible all drugstore chains try to fill the prescriptions with generic medications which have higher profit margins
Walgreens: the company was founded in 1901 by Charles Walgreen, Sr. in Chicago. While the company has existed for more than 100 years, most stores are only 5-10 years old. This is the best managed company among the three drugstore chains and also among the most admired public companies in the US. The company has been run by executives with proven track records and hires the top graduates from universities. Due to its superior financial strength--S&P A+ rating-- and premium irreplaceable locations, properties with leases from Walgreens get the highest price per square foot and/or the lowest cap rate among the 3 drugstore chains. In addition, Walgreens gets flat rent or very low rent increase for 20 to 60 years. The cap rate is often in the low 6% to 7.5% range in 2009. Investors who buy Walgreens tend to be more mature, i.e. closer to reTirement age. They are looking for a safe investment where it's more important to get the rent check than to get appreciation. They often compare the returns on their Walgreens investment with the lower returns from US treasury bonds or Certificate of Deposits from banks. Walgreens opened many new stores in 2008 and 2009 and thus you see many new Walgreens stores for sale. It will slow down this expansion in 2010 and focus on renovation of existing stores instead
CVS: CVS Corporation was founded in 1963 in Lowell, MA by Stanley Goldstein, Sidney Goldstein, and Ralph Hoagland. The name "CVS stands for Consumer Value Stores". As of 2009, CVS has about 6300 stores in the u.s., mostly through acquisitions. In 2004, CVS bought Eckerd Drugstores mostly 1.200 in Texas and Florida. In 2006, CVS bought 700 Savon Osco drugstores and mostly in Southern California. And in 2008 CVS acquired 521 Longs Drugs stores in California, Hawaii, Nevada and Arizona for $ 2.9 (B) Dollars. The acquisition of LongDrugs appears to be a good one as it CVS does not have any stores in Northern CA and Arizona. Besides, the price also included real estate. It is also bought Caremark, the largest pharmaceutical services company and changed the corporation name to CVS Caremark. When CVS bought 1,200 Eckerd stores, it formed a single-entity LLC (Limited Liability Company) to own each Eckerd store. Each LLC signs the lease with the property owner. In the event of a default, the owner can only legally go after the assets of the LLC and not from any other CVS-owned assets. Although the owner loses the guaranty security from CVS corporate assets, this author is not aware of any incident where CVS closes a store and does not pay rent.
Rite-Aid: Rite Aid was founded by Alex Grass (he just passed away on August 27, 2009 at the age of 82) and opened its first store in 1962 as "Thrif D Discount Center in Scranton, Pennsylvania. It officially incorporated as Rite Aid Corporation and went public in 1968. By the time Alex Grass stepped down as the company's chAirman and chief executive officer in 1995, Rite Aid was the nation's largest drugstore chain in terms of total stores and No. 2 in terms of revenue. His son, Martin Grass took over but was ousted in 1999 for overstatement of Rite Aid's earnings in the late 1990s. Rite Aid is now the weakest financially among the 3 drugstore chains. In 2007, Rite Aid acquired about Eckerd drugstores 1.850 Brooks and, mostly along the East coast to catch up with Walgreens and CVS. In the process, it added a huge long term debt (currently owes over.69 Billion) and is the most leveraged drugstore chain based on its market value. The integration of Brooks and Eckerd did not seem to go well. Revenue from some of these stores went down as much as 20% after they change the sign to Rite Aid. In 2009, Rite-Aid had over 4900 stores and over Billion in revenues. The figures went down in 2010 to 4780 stores and .53 billion in revenue. On January 21, 2009 Moody's Investor Services downgraded Rite Aid from "Caa1" to "Caa2", eight notches below investment grade. Both ratings are "junk" which indicate very high credit risk. Rite Aid contacted a number of its landlords in 2009 trying to get rent concession to improve the bottom line. In June 2009, Rite Aid successfully completed refinancing .9 Billion of its debts. However, it continues to struggle in 2010 as same store sales decreased 2.5% in June, 1.7% in May, 1% in April, 1% in March., 3.2% in February, and 2.1% in January.
Things to consider when invested in a pharmacy
If you are interested in investing in property leased by a drugstore chains, here are a few things you should consider:
Walgreens, CVS, and Rite Aid - What RE Investors Should Know in 2011