November 19, 2003


A close look at Walgreens and how it grows in world of Shopping Centers.



The strategy is exceptionally simple, but the execution simply exceptional.

Taking unwavering aim at being the most convenient drugstore, Walgreen has blanketed the country with branches, selected only the best, most accessible locations and invested heavily in technology that speeds transactions and enables customers to treat every store in the chain as their local pharmacy.

A major component of the companys convenience positioning has been its systematic shift since 1994 from the in-line spaces (usually in grocery-anchored strip centers) that were once the bedrock of its real estate plan. The move to a street-side location even at the same shopping center gave a great kick, said William A. Shiel, CLS, the companys senior vice president of facilities development. The freestanding format contributed to increases of 30 percent right out of the box, he said.

And collectively, the companys efforts have garnered it undisputed market leadership. Walgreen Co., based in Deerfield, Ill., just concluded its 29th consecutive year of record sales and earnings. In the fiscal year ended Aug. 31, 2003, comparable-store sales were up 8.6 percent and total sales rose 13.3 percent, to $32.5 billion. (Second-ranked CVS has roughly the same number of stores, but about three-quarters of the sales.) Its assets include some $3 billion in owned real estate and more than $1 billion in the bank.

With 4,227 stores now in operation in 44 states and Puerto Rico, the company plans to expand beyond 7,000 stores by 2010, a net increase of nearly 500 units a year. For fiscal 2004, Walgreen, which funds its growth through revenues, not debt, has budgeted $1 billion for developing stores, distribution centers and systems.

Walgreen has come by its achievements by literally minding its own business, observers say. In sharp contrast to other drug retailers, it eschews acquisition, and it recruits and develops its management from the ground up. Employees stay with the company for decades. Its 16 top executives have collectively logged 476 years with Walgreen, averaging 30 years apiece.

Theyve always been seen as the innovator in the industry, and one of the key strengths is the company over the years has developed its strategy internally, without outside influence, said Derek Leckow, an investment analyst at Barrington Research Associates, Chicago. That insularity has lent a clarity and discipline to its planning, a consistency to its culture, operations and approach to the marketplace, and a quality to its real estate that have set Walgreen at the forefront of its industry for decades.

Since its founding in 1901, the company has pioneered innovations from computerized systems for filling prescriptions and point-of-sale scanning to the freestanding store format that have redefined drug retailing.

Walgreens figured out earlier than anyone else that convenience would drive the industry, said Andrew P. Wolf, a retail analyst at BB&T Capital Markets, Richmond, Va. Now theyre the most convenient purveyor of health and beauty mass merchandise, and that is a major currency.

A number of trends undergird the companys strategy:

The proliferation of prescription drug plans with set co-payments, making proximity more important than pricing;

The boom in consumption of prescription drugs, whose U.S. sales increased 11.3 percent to $183 billion in 2002 and are expected to reach $446 billion by 2012;

The need to avoid direct competition within shopping centers, as discounters and supermarkets add pharmacies, and drugstores expand their selections of food and mass merchandise;

An increased demand for quick, one-stop shopping, given the metamorphosis of supermarkets and discounters into mammoth supercenters and the demise of the five-and-ten.

At 14,500 square feet (11,000 of that is selling space), a Walgreens is a fraction of the size of a supercenter and easier to navigate. The typical Walgreens stocks some 20,000 items not just the prescription drugs that account for more than 60 percent of sales, but everyday necessities, from lipsticks to tortilla chips, carpet cleaners to crayons, computer mice to mousetraps.

You can get in and out of Walgreens in seven minutes, said Wolf. Its an antidote to the very large box stores.

With a trade area of just 20,000 people (a fifth of the population that supercenters require) Walgreens stores are closer to more homes, too, Shiel points out. The stand-alone stores occupy either a pad at a shopping center or a site across the street from one, at high-traffic, signaled intersections. Today 80 percent of the chains stores fit this model. The freestanding sites enable the chain to offer easy access, dedicated parking, 24-hour service (offered in about 900 stores) and, perhaps most important, drive-through pharmacy windows, a service the company considers integral to its positioning.

Patients really appreciate the convenience of picking up a prescription without getting out of the car, Shiel said. While a drive-through transaction precludes add-on purchases, it ultimately builds loyalty. A busy mom with a sick child may not be in the mood to buy a greeting card or a six-pack of Coke anyway.

Benefits accrue to the rest of the shopping center too, even if, on a given visit, a Walgreens shopper never leaves the car, much less cross-shops, said Johnny Hendrix, senior vice president and director of leasing at Houston-based Weingarten Realty.

People with prescriptions tend to be very loyal, so they bring a lot of customers into the shopping center over and over and over again, Hendrix said. A customer will go to Walgreens 10 times and every time will see where Hallmark Cards is, will know how to get in and out of the center, where the traffic lights are, that its an easy trip. Thats how the synergy works. Its a long-term benefit.

Nevertheless, the Walgreens-led exodus to freestanding stores has been a mixed blessing for strip center landlords.

The community grocery- and drugstore-anchored shopping center doesnt exist anymore, said Glenn J. Rufrano, CEO of New Plan Excel Realty Trust, New York City, which includes 21 Walgreens in its portfolio.

Not every strip center property is able to accommodate a 14,500-square-foot pad for a drugstore with a broad merchandise mix, whether on account of limited acreage, restricted uses or cost. The owner has to decide whether to go with them and build outparcels or let them go, Rufrano said. Where we could move them, we did.

Although Weingarten has a few Walgreens on pads, most of the Walgreens in its portfolio are the older, in-line units. Altogether, it has 14 of the stores fewer than we once did, Hendrix said. Theyre such great operators, and its great to have another pad user interested in good sites, but I wish we had more great people with 15,000 square feet for the in-line stores.

Since 1994, Walgreens has more than doubled its store count. The company began ramping up its expansion in 1984, when it opened its 1,000th store, and it has grown exponentially ever since.

They aggressively built stores through a variety of supply-and-demand cycles, and the reward has been a major position in major markets, as well as increases in comp stores and total sales, said Rufrano. Once again theyve taken the heretics who say, Youre building too much, and proved them wrong.

Few see any risk of overbuilding now, though, considering American demographics, the pipeline of new drugs in the works and the influx of more profitable generics as a host of drugs comes off patent.

I dont see a saturation point in the near future, said Leckow. In the U.S. theres lots of opportunity in markets that arent fully served because of the explosion in consumption of pharmaceutical drugs, which will continue, especially as the population ages.

Despite the seemingly endless opportunity in a segment where sales are outpacing store growth, the other leading drug chains CVS, Rite Aid and Eckerd have contracted their store counts by the hundreds in recent years, scuttling unproductive or mismatched real estate they had acquired and catching up with Walgreens by relocating to freestanding sites.

Walgreens took the more financially challenging path by building organically, but made a great investment, ending up with the best real estate in the best markets and on the best corners, said a New York City-based analyst who follows drugstores but declined to be identified.

Indeed, observers repeatedly cite the quality of the chains real estate as a competitive distinction. The fact that it closed only two of the more than 3,000 stores it opened over the past decade attests to its talent for site selection.

They take only the best corner, said Dennis Tracy, a regional vice president at Commercial Net Lease Realty, Orlando, Fla., whose transactions with Walgreen have largely been land sales. They want to know that no drugstore will come into the market and outposition them in the future.

The vast majority of Walgreens are leased, most of them turn-key, build-to-suit arrangements, Shiel says. (The companys $3 billion in real estate holdings include its warehouses, distribution centers and corporate offices.)

The average store racks up annual sales of $7.1 million, or $654 per square foot. Sites that can reap those kind of results demand not only premium prices, but patience and effort, says Alan Kahn, president of Kahn Development Co., Columbia, S.C. His company, one of many that develop stores for Walgreen, opened four of the stores in the Carolinas in August.

Its harder and slower to do these deals today, because theres frequently something else on the site, a service station or other buildings with tenants, he said. But theyre willing to wait and take the trouble to get the very best.

One payoff has been a healthy market for Walgreens leases. Thanks to the prime real estate and the companys high credit rating AAA from Moodys Investors Service and A+ from Standard & Poors its net leases are viewed as sound investments.

There arent many retailers with a better rating, said Bob Blanz, a senior vice president at Capital Lease Funding, New York City, which has financed Walgreens developers since the mid-1990s. And theyre opening stores at a prolific rate. Strong credit, strong market position and lots of product thats whats most attractive from our vantage point.

The challenge of being the market leader, however, is that ultimately everyone else tries to follow. We have to keep executing better and innovating more, Shiel said. Anybody can copy what youve already done.

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Posted by Craig at November 19, 2003 06:24 PM