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SMALL CENTERS FEAR DRUGSTORE CONSOLIDATION

By Donna Mitchell

Walgreens has expanded by using revenues, not debt, to build new stores.

Small-center operators are watching keenly — in some cases apprehensively — as major drug retailers descend on trade areas, sometimes two and three at a time.

With the chains battling over the sale of prescription drugs and everyday conveniences, shopping center landlords wonder how long these tenants can maintain this pace of expansion, and whether another round of consolidation is at hand.

“There is absolutely going to be a consolidation,” said Terry Kittleson, executive vice president of retail dispositions services for Dallas-based commercial real estate services firm Trammell Crow Co. The company represents some of the national chains in markets that include Denver, Detroit and Houston. “It has happened in every specialized retailing segment.”

The rule of thumb in retail development, Kittleson noted, is that a market can sustain two national retailers of a product line, but when three or more retailers come in, there is not enough market share to sustain them all. Drug chains appear to think the rule doesn’t apply to them, he added.

“They just ignore the fact that the other one is there,” Kittleson said. “They think they are the ones with the best merchandising programs.”

That growth isn’t about to slow down any time soon. Walgreen Co., which presently has 3,700 stores in the United States, hopes to have 6,000 by 2010 and ultimately 10,000, said Michael Polzin, a spokesman for the Deerfield, Ill.-based drugstore chain. (Unlike its competitors, Walgreens funds its expansion using the earnings that its stores generate each year and carries virtually no long-term debt, he added.)

CVS, Woonsocket, R.I., currently operates 4,175 stores and will open about 250 in 2002. Most of these will be newly constructed; others will be relocated from strip centers to freestanding locations. Rite Aid, Camp Hill, Pa., intends to add 40 stores this year to its portfolio of 3,500, said company spokeswoman Sarah Datz. Walgreens and CVS are building new stores in growing retirement markets, including Florida, Las Vegas and Phoenix, where the aging population drives demand for drugstores.

Is this construction frenzy madness? Not according to some. There is one very good reason for these companies to continue their current expansion: The market demands it, said Neil Currie, a New York City-based chain drugstore analyst at UBS Warburg. Prescription drugstore sales grew between 10 percent and 12 percent at the end of 2001, and the industry is expected to sustain that growth for the next five years, he said. By comparison, the number of pharmacy prescription counters is growing at a pace of 1 percent a year — and that includes the pharmacy counters that Wal-Mart Stores and other retailers are adding on.

“There is very much a mismatch,” said Currie, adding that a shortage of new pharmacists is aggravating the problem. “There will be continued demand for prescription drugs similar to the rate that we’ve seen. The better stores will take advantage of that growth and build momentum for front-end sales.”

Currie identifies Walgreens as one of those better stores, praising its business strategy and practices. Not only are its expansion goals realistic, but it has the financial resources to execute them, he said.

Neither does Currie fault the drugstores for locating within spitting distance of one another, especially in urban settings. The process for picking sites is much more complicated than simply going where the competition is, he said, explaining that the stores operate in very small trading areas of about one square mile or less.

According to CVS research, consumers dislike traveling more than a mile for the everyday necessities that drugstores provide, said Todd Andrews, director of corporate communications at CVS. Andrews said CVS likes urban areas because they are densely populated and well traveled, making them hot growth markets.

“You want to be where it is convenient for consumers to find you,” he said.

In fact, said Currie, the impression people have of a drugstore pack mentality is exaggerated. Only 16 percent of CVS stores currently operate within 1.5 miles of a Walgreens or Rite Aid store, he said.

However, a report released last month by Retail Forward, a Columbus, Ohio-based market research firm, was less sanguine. Strong drug sales in 2001 have not translated into strong profits, and both sales and profits are likely to decline in the next five years, partly due to tough competition, the firm predicts.

Nevertheless, not all developers are expressing concern about overbuilding. Though this might be an issue for some suburban markets, it isn’t for urban environments, said Bernard J. Rosenshein, president of Mamaroneck, N.Y.-based Rosenshein Associates, a major developer of community and neighborhood centers. The company, which also specializes in developing drugstores in New York City boroughs, has completed freestanding projects lately for Walgreens and CVS. The privately held developer builds about three or four drugstore projects a year in the city’s boroughs.

Rosenshein said the pace of development in the boroughs will slacken as a result of the lack of sites, not from overbuilding. “It is getting tougher and tougher to acquire sites that are satisfactory for drugstore chains,” he said.

Some also question whether fears about further consolidation have any basis.

“Most of the consolidation in the industry has already occurred,” said Walgreen’s Polzin, adding that the Federal Trade Commission would heavily scrutinize any further combination of stores.

Consolidation fever hit the industry in the late 1990s, when CVS Corp. acquired Revco D.S., and Rite Aid bought the Thrifty PayLess chain. The federal government blocked a 1996 proposed merger between Rite Aid and Revco, citing competitive concerns (SCT, May 1997).

More recently, The Jean Coutu Group, Longueuil, Québec, bought 80 Osco Drug stores from Boise, Idaho-based Albertson’s. The group completed the $240 million purchase in February and has already incorporated the stores, mostly located in the Boston area, under its Brooks Pharmacy banner.

But even if another round of consolidation is in the wings, not all developers fear it.

“It’s not a concern,” said Rosenshein, arguing that consolidation would allow strong retailers to overtake their weaker competitors. “It might be good in the long run.”

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