Health Care Reform Bill Summary - Walgreens, Cvs, and Rite Aid - What Re Investors Should Know
Good morning. Now, I learned all about Health Care Reform Bill Summary - Walgreens, Cvs, and Rite Aid - What Re Investors Should Know. Which is very helpful in my experience therefore you. Walgreens, Cvs, and Rite Aid - What Re Investors Should KnowThere 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 2012:
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1. Walgreens ranks first with store cap of .51 Billion, .2 Billion in 2011 total wage (.1B from designate revenues), and an S&P rating of A. According to Walgreens, 75% of the Us population lives within 3 miles from its stores. In April 2010, it acquired 258 Duane Reade drug stores in New York Metropolitan area which brings a total of 7841 drug stores Walgreens operates as of February 2012, together with 137 hospital on-site pharmacies.
2. Cvs ranks second with store cap of .56 Billion, 7.1 Billion in wage (.5 Billion from Cvs designate revenues and .1B from its Caremark designate mail order revenue), and an S&P rating of Bbb+. As of December 31, 2011, Cvs operates 7404 drug stores.
3. Rite Aid ranks third (fourth, behind Walmart in terms of designate revenues) with store cap of .49 Billion, .1 Billion in wage (.1B from designate revenues), operates 4714 drug stores as of February 2011 and has an S&P rating of B-.
Investors buy properties busy by these drugstore chains for the following reasons:
1. The drugstore business is very recession-insensitive. population need medicine when they are sick, regardless of the state of the economy. Both rich and poor population in the Us have way to medicine. Some even argue that low-income population 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.
2. The drugstore business has a good hope in the Us:
· population are living longer and need more medicine to sustain longevity, e.g. Actonel for osteoporosis, Aricept for Alzheimer's symptoms. Older population tend to use more medicine than younger ones as they often have more curative problems. As the 78 million baby boomers are getting closer to retiring age starting from 2008, the drugstore chains anticipate the quiz, for medicine to increase in next 20 years.
· The drug store continues to progress as the Us population continues to grow. More and more Americans suffer from various diseases. The estimate of Americans suffers from seasonal allergies doubled in the last 15 years to 37 million population 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, along with high cholesterol at younger and younger ages. In addition, doctors also propose treating various diseases sooner than later due to best comprehension about the diseases. For example, doctors now designate antiretroviral drugs for patients soon after infected with Hiv virus instead of waiting for the infection to become Aids. More doctors couple 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.
· progress in genetic engineering has introduced various new genetic Dna testing kits which allow the genetic pathology of vulnerabilities to inherited diseases and disorders. Genetic testing is currently the top increase segment in the diagnostics industry. Some of these genetic tests will probably transform into direct-to-consumer testing kits ready in drug stores in the near future.Upon Fda approval, these new products will potentially bring in additional wage for drug stores.
· Using a new formula of tailoring molecules called structure-based design; drug fellowships come up with new medicines that they might not have discovered otherwise, e.g. Xalkori by Pfizer to treat lung cancer.
· The passage of condition Care Reform Bill on March 23, 2010 provides insurance coverage to an estimated 33 million more American. This is a great present to the drugstore industry.
· There are new drugs to treat previously untreatable illnesses, and new diseases, e.g. Viagra for men's unhappiness, Avastin for colon cancer, Herceptin for breast cancer,. The new medicines are very expensive, e.g. A year's supply of Avastin costs about ,000. Eli Lilly has sold about .8 billion of Zyprexa in 2007 for schizophrenia and yet most population have never heard of this medicine.
· There are existing drugs now stylish to treat new illnesses and thus increase their sales revenue. For example, Lyrica was originally intended to treat pain caused by nerve damagein population with diabetes. It is now stylish by Fda to treat Fibromyalgia which affects 5.8 million Americans per WebMd.
· Big advances in genetics, biology and stem cells study are predicted to yield a new class of drugs to treat diabetes, Parkinson's and various rare genetic disorders. For example the new drug Ilaris from Novartis targets genetic causes of an inherited disorder that there are only 7000 known cases worldwide. However, Novartis hopes to moderately broaden its drugs to a blockbuster drug to more coarse disorders caused by similar genetics.
· Technology and modern life introduce and need new products, e.g. Reproduction test kits, Lamisil for stronger clearer toe nails, Latisse for longer & thicker eyelashes, Propecia for male hair loss, Premarin for menopausal symptoms, diabetic monitors, electronic toothbrushes, experience lenses, lenses cleaners, diet pills, vitamins, birth-control pills, Iuds, nourishment supplements and Cholesterol-lowering pills (Americans spent nearly B in 2006 on Cholesterol medications alone per Ims Health, a Connecticut-based consulting business that monitors pharmaceutical sales.)
· 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 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. Cvs reported that non-pharmacy sales represented 30% of the company's total sales in January of 2007. The form for Walgreens is 34% and 37% for Rite Aid. Many pharmacy locations are in corollary convenience stores especially ones that are in residential or rural areas. And so Walgreens hopes that customers also pick up Wd-40, and screwdrivers 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 sacrifice the estimate 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 store as a estimate of enormously popular brand-name blockbusters 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.
· Many population are addicted to pain killers, e.g. Hydrocodone/Oxycodone. Per the Dea in 2012, there are 1.5 million American addicted to cocaine but 7 million addicted to designate drugs.
· This author estimates that at least 10% of the dispensed designate drugs are not used at all and sit idle in the medicine cabinets. They are eventually expired and thrown away.
3. These fellowships sign very long-term Nnn leases, guaranteed by their corporate assets. This makes the investment in the underlying asset fairly low risk, especially for Walgreens with a S&P "A" rating. In fact, these properties are sometimes referred to as investment-grade properties. Once the drugstore chains sign the lease, they pay the rent right away 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 fellowships may sublease the properties to other companies, e.g. progress Auto Parts and continue to pay rents on the specialist leases.
· A typical Walgreens lease consists of 20-25 year former term plus 8-10 five-year options. during former 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 former term plus 4-5 five-year options. The rent is ordinarily flat during the former term and then there is a 2.5%-10% rent increase in each 5-year option.
· A typical Rite Aid lease consists of 20-25 year former 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 complex in your investment:
1) The main downside about investing in pharmacies is there is small or no rent bump for a long time, e.g. 20-50 years, especially for Walgreens. So the rent is effectively reduced after inflation is factored in. This is one of the main reasons these properties do not request for retrial to younger investors, especially when the cap rate is low.
2) The 3 drugstore chains now have a new formidable competitor, Walmart. Walmart sells designate drugs in more than 4000 Walmart, Sam's Club and Neighborhood store stores in 49 states. As of 2012, Walmart is the third largest drug retailer with .4B in designate sales, just ahead of Rite Aid with .1B in designate sales. The sell giant is known for launching in 2006 a highly-publicized generic designate drug program which now sells 350 generic medications for a 30-day supply. The actual estimate of medications is less as the medications with dissimilar strengths are counted as dissimilar medications. For example, Metformin 500 mg, 850 mg, and 1000 mg are counted as 3 medications. Walmart probably makes very small profits on these medications if any. However, the marketing campaign--created by Bill Simon, the President and Ceo of Walmart Us, generates a lot of publicity for Walmart. Walmart hopes to draw customers to its stores with other prescriptions where it has higher profit margins. In an unscientific search for with just one brand-name designate of Lyrica, this author finds the lowest price at Costco, the top price at Walgreens and Walmart at the middle. Other drug chains try to counter Walmart in dissimilar ways. Target now offers the same 350 generic medications for for a 30-day supply. Walgreens has a designate drugs club with membership fee which offers 1400 generic medications for as small as /week. Cvs says it will match any offers from its competitors.
3) Chief business Correspondent Rick Newman from Us World & News narrative predicted that Rite Aid might not survive in 2009. Rite Aid is still colse to in 2012. The prediction seems to go away in 2012 as Rite Aid as it was able to refinance the long terms debts and sales wage has increased.
4) 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 7Pm 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 lower wage brackets. And some baby boomers don't want their prescriptions filled at Target or Walmart because there are no comfortable chairs for them to sit down and wait for their medicines.
5) Drugs sell business to some degree is controlled by the Pharmacy Benefits Managers (Pbms). Customers ordinarily get designate coverage from their condition insurance companies, e.g. Blue Cross. These Pbm manage designate benefits on profit of the insurance companies. In 2012 Walgreens lost a covenant valued at over Billion with Express Scripts, a major Pbm. Walgreen wage was immediately fallen in the first quarter of 2012 as Express Scripts customers cannot fill their prescriptions at Walgreens. The Pbms are also in the drugs sell business via mail orders which do not need leasing expensive sell spaces. The designate mail orders currently capture over 20% store share of the total designate revenue. Should customers turn their designate buy habits to mail orders (there is no such evidence in 2012), it could have negative impact to the business of drugstore chains.
6) Many leases in areas with hurricanes and tornadoes are Nnn leases with the exception of roof and structure. So if the roof is damaged, you will have to pay for the expenses.
7) The tenant may move to a new location down the road or over the street when the lease expires. This risk is high when the asset is placed in small town where there is low barrier for entry, i.e. Lots of vacant & developable land.
8) The tenant may ask for rent concession to improve its lowest line during tough times. The possibility is higher if the tenant is Rite Aid and if the store has low sales wage and/or higher than store rent.
9) More Americans are walking away from their prescriptions, especially the most expensive brand-name medicines. This may have negative impact on the sales wage and profits of drug stores and consequently may cause drug store closures. According to Wolters Kluwer Pharma Solution, a health-care data company, nearly 1 in 10 new prescriptions for brand-name drugs were abandoned by population with industrial condition plans in 2010. This is up 88% compared to 4 years ago just before the retreat began. This trend is driven in part by higher and higher co-pays for 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 superior locations. Walgreens tends to hire only the top graduates from pharmacy schools while Rite Aid settles with lowest graduates to save costs. When possible, all drugstore chains try to fill the prescriptions with generic medications which have higher profit margins.
1) Walgreens: the business was founded in 1901 by Charles Walgreen, Sr. In Chicago. While the business has existed for more than 100 years, most stores are only 5-10 years old. This is the best managed business among the three drugstore chains and also among the most admired communal fellowships in the Us. The business has been run by executives with proven track records and hires the top graduates from universities. Due to its first-rate financial strength--S&P A rating-- and superior irreplaceable locations, properties with leases from Walgreens get the top price per quadrate foot and/or the lowest cap rate among the 3 drugstore chains. In addition, Walgreens gets flat rent or very low rent increases for 20 to 60 years. The cap rate is often in the low 5% to 6.5% range in 2012. Investors who buy Walgreens tend to be more mature, i.e. Closer to withdrawal age. They are looking for a safe investment where it's more important to get the rent check than to get appreciation. They often correlate 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 beyond and focus on renewal of existing stores instead.
2) Cvs Pharmacy: 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 Us, mostly through acquisitions. In 2004, Cvs bought 1,200 Eckerd Drugstores mostly in Texas and Florida. In 2006, Cvs bought 700 Savon and Osco drugstores mostly in Southern California. And in 2008 Cvs acquired 521 Longs Drugs stores in California, Hawaii, Nevada and Arizona for .9B dollars. The acquisition of Long Drugs appears to be a good one as it Cvs did not have any stores in Northern Ca and Arizona. Besides, the price also included real estate. It is also bought Caremark, one of the largest Pbms 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 asset 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 safety from Cvs corporate assets, this author is not aware of any incident where Cvs closes a store and does not pay rent.
3) Rite-Aid: Rite Aid was founded by Alex Grass (he just passed away on Aug 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 communal in 1968. By the time Alex Grassstepped down as the company's chairman and chief menagerial 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 wage in the late 1990s. Rite Aid is now the weakest financially among the 3 drugstore chains. In 2007, Rite-Aid acquired about 1,850 Brooks and Eckerd drugstores, mostly along the East coast to catch up with Walgreens and Cvs. In the process, it added a huge long term debt and is the most leveraged drugstore chain based on its store value. The integration of Brooks and Eckerd did not seem to go well. wage from some of these stores went down as much as 20% after they turn 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 estimate of its landlords in 2009 trying to get rent concession to improve the lowest line. In June 2009, Rite Aid successfully completed refinancing .9 Billion of its debts. In 2012, Rite Aid benefits from Walgreens covenant qoute with Express Scripts. Same store sales increased 2.2%, 3.2%, and 3.6% for January, February and March of 2012, respectively. Rite Aid is still losing money in fiscal year 2012 which ended in March 3, 2012. However, it is losing less, .43 per share in 2012 versus .64 per share in fiscal year 2011. The business expects best outlook in fiscal year 2013.
Things to reconsider when invested in a pharmacy
If you are concerned in investing in a asset leased by drugstore chains, here are a few things to consider:
1. If you want a low risk investment, go with Walgreens. In stable or growing areas, the degree of safety is the same either the asset is in California where you get a 5.5% cap or Texas where you may get a 6.5% cap. So, there is no essential advantage to spend in properties in California as the asset value is based primarily on the cap rate. In 2012, the offered cap rate for Walgreens seems to come down from 7.5%-8.4% in 2009 to 5.5%-6.5% for new stores.
2. If you are willing to take more risk, then go with Rite-Aid. Some properties outside of California may offer up to 9% cap rate in 2012. However, among the 3 drug chains, Rite Aid has 10.5% occasion of going under in 2010. Should it speak bankruptcy, Rite Aid has the selection to pick and pick which locations to keep open and which locations to cease the lease. To minimize the risk that the store is shuttered, pick a location with strong sales and low rent to wage ratio.
3. Financing should be an important consideration. While the cap rate is lower for Walgreens than Rite Aid, you will be able to get the best rates and terms for Walgreens.
4. If you are not a conservative investor or risk taker, you may want to reconsider a Cvs pharmacy. It has Bbb+ S&P credit rating. Its cap rate is higher than Walgreens but lower than Rite Aid. Some leases may offer best rent bumps. On the other hand, some Cvs leases, especially for properties in hurricane areas, e.g. Florida are not truly Nnn leases where landlords are responsible for the roof and structure. So make sure you adjust the cap rate down accordingly. Some of the Cvs locations have onsite Minuteclinic staffed by registered nurses. Since this clinic idea was introduced recently, it's not clear having a clinic inside Cvs is a plus or minus to the lowest line of the store.
5. All 3 drugstore chains have similar requirements. They all want very visible, standalone, rectangular asset colse to 10,000 - 14,500 Sf on a 1.5 - 2 acre lot, preferably at a angle with about 75 - 80 parking spaces in a growing and high traffic location. They all need the asset to have a drive-through. Hence, you should avoid purchasing an inline property, i.e. Not standalone and asset with no drive-through windows. There is a occasion that these drugstores may not want to renew the lease unless the asset is placed in a densely-populated area with no vacant land nearby. In addition, if you regain a asset that does not meet the new requirements, for example a drive-through, you may have a qoute getting financing as lenders are aware of these requirements.
6. If the pharmacy is opened 24 hours a day, it is in a best location. Drugstore chains do not open the store 24 hours day unless the location draws customers.
7. Many properties may have a ration lease, i.e. The landlord can get additional rent when the store's every year wage exceeds a confident figure, e.g. M. However, the wage used to compute ration rent often excludes a page-long list of items, e.g. Wine and sodas, tobacco products, items sold after 10 Pm, drugs paid by governmental programs. The excluded sales wage could account for as much as 70% of store's gross revenue. As a result, this author has seen only 2 stores in which the landlord is able to regain additional ration rent. The store with a ration rent is required to narrative its every year sales to the landlord. As an investors, you want to spend in a store with strong gross sales, e.g. Over 0 per quadrate foot a year. In addition, you also want to check the rent to wage ratio. If the form is in the 2-4% range, the store is likely to be very profitable so the occasion the store is shut down is low.
8. It does not matter how good the tenants are, avoid investing in declining, e.g. Detroit and/or low-income areas or small towns with less than 30,000 residents within 5 miles ring. In a small town, it may be the only drug store in town and captures most of the store share. However, if a competitor opens a new location in the area, wage may be severely affected. In addition, the tenant can all the time moves to a new location down the road when the lease expires since there is low barrier to entry in a small town. These properties are easy to buy now and hard to sell later. When the credit store is tight, you may have problems looking a lender to finance these properties.
9. Many properties have an existing loan that the buyer must assume. If you have a 1031 exchange, think twice about buying this property. You should clearly understand loan assumption requirements of the lenders before engaging forward. Should you fail to assume the existing loan (assuming an existing loan is a lot more difficult than getting a new loan), you may run out of time for a 1031 replacement and may be liable to pay capital gain.
10. With few exceptions, drugstore chains do not own the stores they occupy for several reasons. Here are just a couple of them:
- They know the pharmacy business but don't know real estate. Stock investors also don't want Walgreens to become a real estate investment company.
- Owning the real estate will need them to carry lots of long term debts which is not a brilliant idea for a publicly-traded company.
11. About 10% of the drugstore properties for sale and typically Cvs pharmacies need very small estimate of equity to acquire, e.g. 10% of the buy price. However, you are required to assume an existing fully-amortized loan with zero cash flow. That is, all of the rent paid by the tenant must be used to pay down the loan. The cap rate may be in the 7-9% range, and the interest rate on the loan could be engaging in the 5.5% to 6% range. Hence, the investor pays off the loan in 10 to 20 years. However, you have no confident cash flow. This requires you to come up with outside cash to pay wage tax on the rental profits (the contrast in the middle of the rent and mortgage interest). The longer you own the property, the more outside cash you will need to pay wage taxes as the mortgage interest will get less and less toward the end. So who would buy this kind of property?
- The investors who have grand losses from other investment properties. By acquiring this zero cash flow property, they may offset the wage from the drugstore tenant against the losses from other investment properties. For example, a asset has 5,000 of rental profits a year, and the investor also has losses of 0,000 from other properties. As a result, the combined assessable profits are only ,000.
- The uninformed investors who fail to reconsider that they have to raise additional cash to pay wage taxes.
Out of the Box Thinking
If you put too much weight on the S&P rating of the tenants, you may end up either taking a lot of risks or passing up good opportunities.
A Good location should be the key in your decision on which drug store to spend in. It's often said a lousy business should do well at a great location while the best tenant will fail at a lousy location. A Walgreens store that is closed down later on (yes, Walgreens closed 119 stores in 2007) is still a bad investment even though Walgreens continues paying rent on time. So you don't want to blindly spend in a drug store simply because it has a Walgreens sign on the building.
No business is crazy enough to close a profitable location. It does not take rocket science to understand that a financially-weak business like Rite Aid will make every endeavor to keep a profitable location open. On the other hand, a financially-strong Walgreens will need justifications to keep an unprofitable location open. So how do you determine if a drug store location is profitable or not if the tenant is not required to disclose its profit & loss statement? The reply is you cannot. However, you can make an educated guess based on the store's every year gross wage which is often reported to the landlord as required by the ration clause in the lease. With the gross revenue, you can determine the rent to wage ratio. The lower the ratio, the more likely the store is profitable. For example, if the every year base rent is 0,000 while the store's gross wage is M then the rent to wage ratio is 5%. As a rule of thumb, it's hard to make a profit if this ratio is more than 8%. So if you see a Rite Aid with 3% rent to wage ratio then you know it's likely a very profitable location. In the event Rite Aid declares bankruptcy, it will keep this location open and continue paying rent. If you see a Rite Aid drug store with 3% rent to wage ratio contribution 10% cap, chances are it's a low risk investment with good returns and the tenant will most likely to renew the lease. The infirmity of corporate guaranty from Rite Aid is probably not as essential and the risk of having Rite Aid as a tenant is not no ifs ands or buts that significant.
Drug stores with new 25 years leases tend to sell at lower cap, e.g. 6-7% cap on new stores versus 8.0-8.5% cap on established locations with 5-10 years remaining on the lease. This is because investors are afraid that the tenants may not renew the leases. Unfortunately, lenders also have the same fear! As a result, many lenders will not finance drug stores with 2-3 years left on the leases. The fact that drugstores with new leases have a superior on the price means they have possible of 20% depreciation (buying new at 6% cap and selling at 7.5% cap when the leases have 8 year left). Some investors will not reconsider investing in drug stores with 5-10 years left on the lease. They might simply ignore the fact that the established stores may be at irreplaceable locations with very strong sales. Tenants simply have no other choices other than renewing the lease.
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