Drugstore Overviews

CVS Pharmacy Tenant Report

CVS faces challenges and reboots strategy amidst declining profit margins

In late 2021, CVS Health Corporation, grappling with declining profit margins and evolving consumer habits, announced plans to close approximately 900 of its U.S. stores over a three-year period starting in spring 2022. This strategic move is part of CVS’s broader vision to “reimagine primary care” and create a next-generation primary care model. The closure plan aims to streamline operations and optimize CVS’s store footprint in response to population shifts and changing consumer spending patterns.

Key Issues Impacting CVS

1. Falling Reimbursement Rates: CVS, like its competitors, faces significant pressure from falling prescription drug reimbursement rates. Pharmacy Benefit Managers (PBMs) such as CVS Health’s own Caremark have been accused of imposing lower reimbursement rates, which often leave pharmacies struggling to cover costs. This challenge is compounded by the fact that CVS, despite having its own PBM, still feels the squeeze on its margins.
2. Retail Pressure: Inflation and increased competition from e-commerce giants like Amazon and big-box retailers such as Walmart and Target have further strained CVS’s retail business. The front-of-store segment, which includes non-pharmacy items like snacks and personal care products, is seeing reduced consumer spending. Inflation has pushed price-sensitive shoppers towards more cost-effective options.
3. Workforce Challenges: The pharmacy sector is also dealing with widespread burnout among staff, who report high workloads and understaffing. This issue has been exacerbated by the pressure of maintaining service levels amidst declining profit margins.

CVS’s Strategic Response

In response to these challenges, CVS is implementing several strategic changes:

1. Store Closures and Streamlining: CVS has announced plans to close approximately 900 stores, about 10% of its U.S. locations, over the next three years. This decision is part of a broader effort to optimize its store footprint based on population shifts and consumer spending patterns. By the end of 2024, CVS aims to have shuttered 851 stores, focusing on maintaining access to pharmacies within a 10mile radius for most Americans.
2. Innovations and New Models: CVS is exploring new models to better serve its customers. This includes integrating its retail pharmacies with primary care centers through Oak Street Health. The company plans to open around two dozen new centers by the end of the year. Additionally, CVS has introduced a new pharmacy reimbursement model, CostVantage, designed to offer more transparency and predictability in medication pricing.
3. Private Label Expansion: To counteract the impact of inflation and changing consumer habits, CVS is expanding its private-label product offerings. This strategy aims to attract budget-conscious shoppers and offer more competitive pricing on essential items.

This announcement has led real estate investors to question whether brand-name drugstores remain a sound investment. CVS has traditionally seen its net lease properties—ranging in transaction prices from $4.6 million to over $20 million—highly valued by passive rental income investors. However, the planned store closures have led to concerns among real estate investors about the future value of these properties. With more than 1,015 CVS net lease transactions completed in the past 24 months, factors such as net operating income, location, and lease terms continue to influence property valuations. For real estate investors, it is crucial to evaluate how these shifts might impact their CVS properties, considering whether the locations can adapt to the new store formats and healthcare services.

Walgreens Tenant Report

Walgreens reassesses strategy as store closures loom

Currently, Walgreens is undergoing a major strategic overhaul as it contends with declining profits and a rapidly evolving retail landscape. With its stock price plummeting roughly 80% over the past five years to around $9 per share, and narrowed earnings forecast of $2.80 to $2.95 per share, the company is reevaluating its business model under new CEO Tim Wentworth. It is now focusing on reducing its store count and rethinking its business model to adapt to current market pressures.

Challenges Facing Walgreens

1. Decreasing Profit Margins: Walgreens has experienced a significant drop in its pharmacy profit margins, with its U.S. retail pharmacy unit reporting a -5% operating margin last year. This decline is largely attributed to falling reimbursement rates for prescription drugs, compounded by high operational costs and intense competition.
2. Retail Sector Struggles: The company’s front of-store business, which includes everyday consumer products, is facing difficulties due to inflation and increased competition from e-commerce and discount retailers. Consumers are increasingly turning to Walmart, Amazon, and other retailers for better pricing on essentials, impacting Walgreens’ retail sales.
3. Operational Efficiency: Walgreens is also dealing with operational inefficiencies, including staffing shortages and the challenge of balancing customer service with high workload pressures.

Walgreens’ Strategic Adjustments

To address these challenges, Walgreens is implementing several key strategies:

1. Store Closures: Walgreens has announced plans to close up to 25% of its 8,600 U.S. stores. This decision is part of a broader strategy to eliminate underperforming locations and optimize its store portfolio. CEO Tim Wentworth has indicated that closures will focus on locations with lower profitability and those impacted by theft or redundancy.
2. New Store Formats: Walgreens is experimenting with smaller-format stores that emphasize convenience and digital solutions. For example, new locations feature streamlined layouts with fewer front-of-store items and enhanced pharmacy services. The company is also piloting stores with reconfigured pharmacy placements to improve operational efficiency.
3. Investment in Digital Solutions: In response to changing consumer behavior, Walgreens is investing in digital tools to improve customer experience and operational efficiency. This includes expanding its digital pickup options and exploring ways to better integrate its pharmacy and retail services.

Walgreens is also contemplating a potential exit from the primary care market, having faced challenges with its investment in VillageMD. The company has recorded significant charges related to the decline in value of this investment and is reassessing its position in this segment. As Walgreens moves forward, it will need to balance cost-cutting measures with the need to remain a viable and accessible healthcare provider. The company’s ability to adapt to the evolving retail environment and maintain its role in American healthcare will be crucial for its long-term success. Experts believe that focusing on specialty pharmacy services and leveraging its Shields Pharmacy Solutions subsidiary could aid in Walgreens’ recovery. While the company faces a tough road ahead, there is cautious optimism that with strategic changes, Walgreens can bounce back.

Navigating the Aftermath of Rite Aid Owners Facing Vacancies

In November 2023, Rite Aid filed for Chapter 11 Bankruptcy Protection, leading to the closure of over 1,200 stores nationwide—approximately half of its total footprint. This included all locations in Ohio and Michigan, where the remaining prescriptions were sold to Walgreens as part of their restructuring plan. Although Rite Aid has exited bankruptcy, property owners now face the challenge of managing vacant assets. Several factors have contributed to the current market conditions, and there are critical issues for owners to address in this oversaturated landscape.

Key Issues Facing Owners

Ongoing Loan Obligations

Many owners of Rite Aid properties, whether recent purchases or long-held assets, find themselves in debt. Interest rates remain significantly higher than the rates at which most owners initially financed their properties, making it nearly impossible to refinance a vacant asset without a committed tenant. This poses a considerable challenge for those facing upcoming debt maturities. Additionally, ongoing mortgage payments continue to burden owners, regardless of the maturity of their loans, complicating financial management and raising concerns for lenders day by day.

Market Oversaturation

With over 1,2000 store closures nationwide, 38% of which occurred in just two states, the market is flooded with vacant inventory. This sudden and substantial increase in supply, coupled with stagnant demand, has negatively affected achievable lease rates, tenant interest—particularly from national credit tenants—and overall property values. The few properties that have avoided significant impacts are those with exceptional real estate fundamentals, which retailers secured before hitting the market.

What Can Owners Do?

Information Gathering

Collecting all relevant documentation, including loan details and third-party reports from the original purchase (such as environmental studies, property condition assessments, and ALTA surveys), facilitates a smooth future transaction. This information benefits potential buyers or tenants and empowers owners to fully understand their property’s condition and address any issues before they escalate. Being prepared to answer questions about the property is crucial when pricing and during negotiations.

Secure and Prime the Asset

It is vital for owners to re-key the building and ensure that a functioning security system is in place, especially amid the initial panic of vacancy. Maintaining security and providing access for interested parties will help preserve the asset’s condition. Additionally, for properties located in colder regions, winterization and ongoing maintenance are important. Taking proactive measures can protect properties from severe issues like ruptured pipes, flooding, cracked lots, and roof damage, giving owners a sense of security and preparedness.

Stay Informed

Regardless of initial investment or previous value assessments, the market value of the asset has likely changed. While minimizing losses is important, allowing concerns about potential depreciation to drive decisions can lead to missed opportunities and increased costs. By staying informed about market conditions, owners can make strategic decisions that protect their assets and maintain financial stability.

While there is an undeniable urgency for owners to act on their vacant assets, taking the time to make thoughtful and informed decisions is far more important than acting hastily. As more buyers and tenants enter and exit the market, it is crucial for owners to adapt to market conditions rather than resist them. Although many of these assets were originally purchased as hands-off investments, the reality is that owners must now engage on a detailed level to minimize potential losses and protect their equity, as market conditions are unlikely to improve over time. By adapting to these changes, owners can demonstrate resilience and ensure the long-term success of their investments.