Chain drug stores have responded well to the changing marketplace over the past year and bolstered their prospects for growth in 2012, industry analysts say.

chain drug stores, drug retailers, drug chains, Russell Redman, Food & Drug Retailer Outlook, drug stores, prescription sales, leading drug chains, generic drug, patent cliff, generics wave, specialty drug, Deborah Weinswig, Citi Investment Research, Joseph Agnese, Standard & Poor’s Equity Research, pharmacy market, National Association of Chain Drug Stores, pharmacy benefits managers, PBMs, drug channel, Fitch Ratings, pharmacy services, drug store sector, Ann Natunewicz, Colliers, prescription drugs

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Outlook: Drug chains bolster growth prospects

April 23rd, 2012

NEW YORK – Chain drug stores have responded well to the changing marketplace over the past year and bolstered their prospects for growth in 2012, industry analysts say.

“We have a constructive outlook for the drug retailers in 2012, as the companies benefit from the generics wave, specialty drug growth and front-end drivers (mobile/e-commerce growth, fresh food and retail clinics),” Deborah Weinswig of Citi Investment Research wrote in her “2012 Food & Drug Retailer Outlook.” report.

Though the fragile economy has consumers wary, drug chains are better positioned than most other retailers, according to analysts. They cite two key reasons: About two-thirds of drug chains’ revenue comes from prescription drugs — something many people can’t do without — and drug stores are convenient shopping outlets, offering neighborhood locations (a plus when fuel costs rise), competitive pricing and an attractive product mix.

“What’s great for drug chains in an economy like this is that prescription sales hold up relatively well compared with discretionary sales,” Joseph Agnese of Standard & Poor’s Equity Research said in an interview. “Consumer staples sales also hold up well, which is why you see drug stores adding more consumables and shying away from discretionary items, like general merchandise. So there’s been a bit of a shift in the mix at drug stores.”

S&P forecasts same-store prescription sales growing in the low single digits over the next 12 months for the leading drug chains and approaching 70% of their total revenue. Agnese noted that the “big positive” will be the generic drug influx.

“We started to go over the patent cliff in late November and early December, and around May we’ll start to see more generic competition and costs go down significantly for drug stores, which really benefits their margins,” he said.

Citi projects the addressable pharmacy market to expand to $390 billion by 2015, up 42% from 2010 and representing a 7.3% compound annual growth rate (CAGR). Most of the growth will be driven by generics (16.8% CAGR) and specialty drugs (12.1% CAGR), whereas branded drugs will see much less growth (0.2% CAGR) in that time span.

In the front end, chains are differentiating their merchandising via exclusive products, expanded natural/organic offerings, wellness-focused items, enhanced beauty departments, improved convenience (including extended hours and more drive-throughs), SKU rationalization, and new store layouts with wider aisles and smart signage to ease shopping.

“A stable front-end business should help companies maintain gross margins, since such items typically carry wider margins than pharmaceuticals,” Agnese wrote in a drug retail research note. “Additionally, we believe efforts to expand and improve customer loyalty programs will help drive improved marketing and promotional spend efficiency.”

The continued rollout of fresh food offerings, including produce and grab-and-go items, is helping drug chains drive shopping trips and win market share, according to Weinswig.

“Drug stores remain focused on adding fresh food to offer more choice for the consumer and increase traffic and basket size,” she observed, citing National Association of Chain Drug Stores data showing that the average shopper comes to a drug store once per month, well below the 4.75 times per month at a supermarket.

The addition of more e-commerce and mobile capabilities, analysts say, also will give drug chains a lift in the front end (photo orders, e-coupons, store pickup of online orders, reward points balance checks and shopping tools) and in the pharmacy (e-scripts, prescription refills and alerts, prescription transfers, medication management and health information).

On the negative side, drug chains are facing intensifying competition from other retail formats — most recently, dollar stores — and feeling the pinch in drug pricing from budget-crunched states and pharmacy benefits managers (PBMs), according to analysts.

“There are a lot of pressures for drug chains,” Agnese said. “There’s a big merger of PBMs potentially occurring, which could shift some power to PBMs and eventually hurt pharmacies, as well as the distraction of the Express Scripts/Walgreens situation. There are also drug reimbursement pressures, from states especially.

“For large drug chains, there’s some negative impact. But the small pharmacy operators will be hurt a lot more.”

In its “Navigating the Drug Channel” report, Fitch Ratings said tensions between PBMs and drug stores won’t go away.

“Fitch expects PBMs will continue to try to squeeze reimbursement to retail pharmacies and use their mail-order pharmacy services as a platform to take share from drug stores. Retail drug stores, in response, will periodically walk away from a specific PBM network — as seen in the most recent spat between Express Scripts and Walgreens — generally because they believe reimbursement levels are insufficient to compensate them for the services they provide.

“In addition, PBMs may restrict mail-order usage to the PBM’s mail-order pharmacy. Some retail drug stores have countered with 90-day supplies at retail.”

Health reform, meanwhile, carries pluses and minuses for chain drug stores, Fitch observed in its “2012 U.S. Retail Outlook.”

“Ongoing health care reform initiatives could pressure reimbursement rates but be positive for prescription volume over the intermediate term, if a prescription plan is put in place for the uninsured,” the report said.

Aside from prescription file buys and potential fill-in acquisitions, national drug chains will look less to new store locations to grow market share, analysts say, noting that store openings (except remodels and relocations) have slowed industrywide. Still, the largest chains are more active on that front than other retailing segments, according to Colliers International.

“The drug store sector remains one of the few retail categories with three national players remaining,” analyst Ann Natunewicz stated in Colliers’ “U.S. Highlights: 2012 Retail Outlook” report. “Recently, each of the chains has reiterated its 2012 real estate program: Walgreens (150-200 new stores), CVS (250-300) and Rite Aid (100). Collectively, these expansions represent some of retail’s most aggressive store-opening schedules.”

Perhaps the best indicator of the chain drug industry’s prospects are long-term demographic trends that favor its core business: prescription medication services.

“The youngest baby boomers are in their late 40s, and from about that age onward is when you start to see that significant increase in demand and utilization of prescription drugs,” S&P’s Agnese said. “So for the next 20 years you’re going to see that trend continuing.”

*To read the full State of the Industry 2012 report, including economic analysis, drug chain profiles, interviews with chain drug retailing leaders, and industry trend articles, please see the April 23, 2012, print issue of Chain Drug Review.