Rising gas prices have cast a cloud over recent same-store sales gains by mass retailers, yet the hike in fuel costs — and overall prices due to inflation — stands to have less of an impact on drug store chains, industry analysts say.

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Analysts: Drug chains can weather rising fuel prices

May 6th, 2011

NEW YORK – Rising gas prices have cast a cloud over recent same-store sales gains by mass retailers, yet the hike in fuel costs — and overall prices due to inflation — stands to have less of an impact on drug store chains, industry analysts say.

Getting a lift from this year's later Easter, retailers turned in an 8.7% weighted composite gain in same-store sales (excluding Walmart) for April, much higher than the 2.5% same-store increase in March and the 1.2% uptick in April 2010, according to Kantar Retail. The research firm tracks monthly retail sales for a sample of about 30 key retailers.

Despite soaring fuel prices, sales growth remained steady for the March-April holiday period versus a year earlier, Kantar noted. For the combined period, same-store sales rose 5.4% compared with 5.7% last year. The researcher said results were led by apparel and accessory stores followed closely by department stores. and food, drug and mass retailers.

The nation's three biggest drug chains — Walgreen Co., CVS Caremark Corp. and Rite Aid Corp. — all posted year-over-year same-store increases for their most recent reporting periods.

In April, comparable-store sales were up 3.4% at Walgreens (versus 3% in March) and grew 0.5% at Rite Aid (versus a 0.1% dip in March.) Walgreens also said comp-store results were up 3.3% for the March-April period (Rite Aid didn't report same-store sales for the combined period). Meanwhile, CVS Caremark this week said same-store sales rose 2.6% for its first quarter ended March 31 (the company doesn't report monthly same-store results).

"The impact of rising fuel prices will become more obvious in the months ahead, but just how obvious depends on how much job and income gains also suffer under the weight of rising fuel prices and economic uncertainty," Frank Badillo, senior economist at Kantar, said in a statement.

Kantar's latest ShopperScape survey indicated that in April surging gas prices took a heavier toll on shopping intentions. The percentage of shoppers planning to spend less in the coming month versus a year ago increased by about 1 percentage point (to 35%) for the second month in a row (in terms of a three-month moving average). Also, the percentage of shoppers planning to spend about the same fell by nearly 1 percentage point to 54%, while the percentage of shoppers planning to spend more than last year held about steady.

According to Kantar, retailers' results will increasingly show some impact from the measures that shoppers are taking to offset the impact of rising fuel prices. Its April ShopperScape poll found that 56% are "planning errands to minimize the distance traveled" and 44% are "going to stores where I can do one-stop shopping." Also, 41% of shoppers said they are "going to stores that are closer to home or work," while 25% said they are "doing more online shopping." And 20% indicated they are "shopping at retailers that offer lower prices or a better deal than where I usually shop."

Such measures to minimize shopping trips and distance should favor drug stores, which compete more on proximity and less on price than other retailers, analysts explained.

"Higher oil prices will pressure the lower- to middle-income consumer. But one of the advantages that can come from higher oil prices is that people will shop more toward convenience — shopping locally rather than driving farther to go to a discount store or supercenter. So that convenience factor actually plays to drug stores' benefit," Joseph Agnese of Standard & Poor's Equity Research told Chain Drug Review in a recent interview.

In a research note about the impact of rising inflation and gas prices on drug retailers, Credit Suisse Equity Research analyst Ed Kelly also pointed to the convenience factor as playing into the hands of drug stores, whose demand he described as "relatively price inelastic".

"Investors have grown increasingly concerned that rising product costs and fuel prices may derail the recovery in consumer spending and pressure retail stocks. Our proprietary analysis suggests that drug stores are among the best-positioned companies to navigate these headwinds," Kelly stated. "We expect the industry to fully pass through front-end inflation and see no material impact from higher gas prices."

In his analysis, Kelly gave three key reasons why drug chains can weather the adverse pricing environment:

• Drug stores compete more on convenience than price. "The companies recognize that
consumers are willing to pay a premium for the convenience of the model," he wrote. "We believe the convenience factor may become increasingly important when fuel prices are high and consumers look to cut back on driving times."

• Low average ticket. "Given the small basket size, [drug store] customers typically do not notice (or do not mind) small price increases," Kelly said. "This allows drug stores to raise prices, especially within a given dollar band (e.g. $4.39 to $4.69), without much impact to volumes."

• Pharmacy feeds front-end traffic. "We believe 30% to 40% of pharmacy shoppers also make a front-end purchase," he wrote. "The pharmacy thus provides a steady flow of traffic that supports front-end sales."

Kelly noted in his report that the last time gas prices hit $4 per gallon, industry volume and total sales rose.

"Historical precedent suggests that drug store sales do not generally suffer when gas prices rise rapidly, unlike for most other retailers. In the previous period of rising gas prices, drug store front-end sales have remained robust, and in some cases have actually accelerated," he stated. "We believe the convenience of the drug store offsets the hit to consumer purchasing power. We do not expect to see a material dropoff in front-end sales if gas prices continue to rise."