Walgreen = Healthcare + Convenience Store
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Drugstore chain Walgreen (NYSE: WAG) has emerged a leader in the convenience store category. The issue for investors is if it can smoothly incorporate that into its traditional retail pharmaceutical branding which, in itself, has expanded into the broader area of healthcare. If not, it becomes, as I see it, a retailer like Staples and Sears with a confusing identity. If it makes it then it could be the kind of game-changer in the c-space that Wal-Mart had been in general retail. There's even the possibility it could create a new model of the old General Store which housed everything, including gossip. That would make it a Third Place, along with Starbucks, Panera, and Whole Foods.
Despite the risks involved, Walgreen is solidly in the c-store niche. According to a CSP Daily News Poll, 63% of responders indicated that the drugstore chain had become more of a threat to c-stores such as 7-Eleven. That convenience positioning seems part of the platform for how it is navigating this era glutted with retail, ranging from Wal-Mart to Kroger, which fills prescriptions. And much of that retail niche is being squeezed in reimbursement rates from pharmacy benefit management services such as Express Scripts. Given that healthcare reform is in play, this retail segment is filled with uncertainty. Investors might welcome diversification of the core business into other niches.
For Walgreen, that "convenience" umbrella covers a continuum of on-the-run food and beverage items, healthcare services such as in-store flu shots, and, of course, no-hassle filling of prescriptions. Can this kind of integration work under one roof? The jury should still be out and it seems to be. The stock is at about 34, with a 52-week range of 30.34 to 45.34. For 2Q, its sales of $18.7 billion were up .08% but earnings per diluted share were 78 cents, down 2.5%.
Like most of retail, Walgreen is in transition. Part of the competition remains the traditional drugstore chains like Rite Aid Corp (NYSE: RAD) and CVS Caremark (NYSE: CVS). Since so many of the three are clustered in the same locations, it’s a dog fight. As yet, there is no distinct differentiation among the three, at least in the consumer's eyes. Perhaps Walgreen is attempting to accomplish that unique positioning through dominance in convenience.
Both Rite Aid and CVS Caremark have had their problems. Recently Rite Aid turned itself around by refinancing part of its debt and with same store sales increasing 3% compared to last year. Fitch changed its outlook from negative to stable. Essentially Rite Aid and Walgreen are playing in the same sandbox with the food and beverage items. CVS Caremark is also there. But in addition CVS, Caremark operates a pharmacy benefit management division. The Federal Trade Commission had investigated CVS Caremark's benefit management business practices for two years. At the end, the company, under a consent order, agreed to pay $5 million in consumer refunds. However, "CVS," as it is known, is an institution in communities and buying habits don't change easily. Also, customers hate to transfer prescriptions.
The other part of the competitive landscape for Walgreen is any retail entity, brick or click, which provides what Walgreen refers to as a convenient affordable solution to the whatevers of “daily living.” In that it aims to be the consumer’s first choice. That means it is taking on the 7-Eleven, owned by Seven & I Holdings Company, Chevron’s mashups of gas and snacks, urban bodegas, and the mom-and-pops which have survived amidst the chains.
In the c-space, Walgreen is succeeding. The NPD Group reports that while c-store traffic was down 1.4%, Walgreen was up by the same percentage. There it’s not alone, though. The drugstore channel also siphoned off market share from discount clubs and mass merchandisers. The sweet spot is one-stop shopping in a small-sized store, geared for in-and-out purchasing. This especially appeals to busy females. Also, in sort of a Norman Rockwell manner, drugstores have or had an aura of trust. Main Street was and is still used to talking with neighorhood pharmacists about sensitive medical issues. It also depends on them to pick up possible dangerous interactions among medications.
Will that trust erode now that we can walk into a Walgreen, some open 24/7, and purchase alcohol, tobacco, sushi, flowers, postage stamps, hot coffee and much more? This summer we can get our electric car charged at some of its stores. This seems to be Walgreen's version of the gas stations which are part of the convenience store formula.
For this, it does have a location edge. That comes from its ability as a deep pocket corporation to afford to pay for high traffic areas. In selecting them, it makes it its business to be within 5 miles of where 75% of consumers live. That creates the neighborhood store feel, where many can even walk and if they drive not use much gas. Its store where New Haven and East Haven, Connecticut intersect attracts foot traffic from the 1400 unit Bella Vista senior citizen complex as well as low income housing developments. This capability could be touted as green, particularly in urban areas. However, there is plenty of parking.
Walgreen enhances these incentives with coupons and special pricing. It's big on private label and a Nielsen study found that 75% of its shoppers purchase those store brands. It is consolidating its existing store labels into one single brand: Nice! They retail at about 30% less than national brands. Managed right, the Walgreen private label niche could become a major business in itself, analogus to Wal-Mart's Sam's Club. It is along the innovative retailers which have taken out-of-the-box steps to keep consumer interest in private label even as the economy improves.
That competitive strength might have factored into its decision to end its relationship with pharmacy benefit manager Express Scripts. And it proved to be, at least, a temporary setback. The decision led to, first of all, the loss of revenues because those Express Scripts customers had to transfer their prescriptions elsewhere. That impacted 2Q earnings negatively by 7 cents. Secondly, that process resulted in public relations negatives. Walgreen was perceived as putting the bottom line ahead of alleged savings benefits for consumers. Walgreen now operates a Subscription Savings Club which provides steep discounts on services such as immunizations and products like brandname and generic prescriptions. Also it expanded the scope of its pharmaceutical business with the $225 acquisition of some of the assets of BioScrip. That company is in the business of community specialty pharmacies and centralized specialty and mail order pharmacy. This gives Walgreen access to HIV, oncology, and transplant patients.
As investors are observing, transition is a tricky busines in retail. Macy’s made it through stronger in the middle segment. Penney and Best Buy seem to be unable to achieve a turnaround, so far. Time will tell if Walgreen, with its roots in retail pharmacy, is making profitable moves.
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