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Walgreen Is Eating Rite Aid's Lunch

Back in June, Walgreen (NASDAQ: WBA  ) reported an earnings miss as the company continued to have trouble driving customer traffic. At the time, Walgreen executives vowed to fight back by ramping up promotional behavior: i.e., offering bigger discounts.

Walgreen is boosting discounts

Since then, Walgreen has come roaring back. The company delivered steady -- if not stellar -- sales growth in its recently ended quarter. Walgreen's return to a more promotional stance is starting to damage smaller rival Rite Aid (NYSE: RAD  ) . A price war plays to Walgreen's strength as the largest drugstore chain in the country, while it could further undermine Rite Aid's already-meager profit margin.

Walgreen: return to sales growth
While many retailers have performed poorly this summer, Walgreen had no such problems. Front-end (i.e., non-pharmacy) sales in comparable stores increased by 0.8% in June. Sales momentum improved thereafter; comparable-store front-end sales grew 2.3% and 2.2% in July and August, respectively.

For the full quarter, front-end comparable-store sales were up 1.7%. That may not seem very impressive, but it represents a significant sequential improvement compared to the 0.4% gain Walgreen registered in the May quarter. Moreover, Walgreen had posted declines in the four previous quarters. Comparable-store prescription count was up an even stronger 6.8% for the quarter, as Express Scripts (NASDAQ: ESRX  ) customers continued to return to Walgreens stores.

Rite Aid is peaking
The story is quite different at Rite Aid. While Rite Aid was the biggest beneficiary of the Walgreen-Express Scripts dispute last year, it's now losing market share to Walgreen once again. Whereas Walgreen reported a 6.8% jump in comparable-store prescription count for the August quarter, the same measure was flat at Rite Aid.

This loss of prescription market share has afflicted Rite Aid for many months now. However, the company is now starting to feel pressure from Walgreen's front-end price initiatives as well.

In June, Rite Aid's front-end comparable store sales grew 0.4%, in-line with the company's trend for this year. In July, this figure ticked up by 30 basis points sequentially to 0.7%, whereas Walgreen saw a much stronger 150-basis-point sequential improvement. Most disturbingly, whereas Walgreen's comparable-store front-end sales growth remained above 2% in August, Rite Aid last week reported a 1.7% drop in that measure for August.

No contest
Walgreen and Rite Aid are both expected to report quarterly earnings later this month. Based on the two companies' relative sales performance, Walgreen investors are likely to be much happier than Rite Aid investors when all is said and done.

Rite Aid has improved its profitability significantly over the past several quarters through margin improvements. However, the benefit from new higher-margin generic drugs is fading now, and pharmacy benefits managers are constantly cutting back on reimbursement rates. An increase in price competition from Walgreen will put even more pressure on Rite Aid's bottom line.

Nevertheless, Rite Aid has little choice but to fight back with its own margin-sapping discounts. Otherwise, it will continue to lose share in the front end. That would be fatal, as front-end sales are a more reliable contributor to profitability than the prescription business, where insurers and pharmacy benefits managers have all the leverage (and take most of the profit). Bottom line: If Walgreen maintains its cutthroat strategy, Rite Aid could be in big trouble.

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Read/Post Comments (10) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 10, 2013, at 6:25 PM, prginww wrote:

    Walgreen without the s? Guys, spell the company name right. Seriously, what the heck are you guys doing?

  • Report this Comment On September 11, 2013, at 10:57 AM, prginww wrote:

    The company name is in fact "Walgreen" with no S. Walgreen Co. operates a chain of drugstores called "Walgreens".

    Similarly "Wal-Mart" is a company that operates a chain of discount stores called "Walmart".


  • Report this Comment On September 11, 2013, at 12:07 PM, prginww wrote:

    In my opinion only, your article about Walgreens having Rite Aid for lunch is far-fetched. The principle in the market is buy low sell high. Do not buy high and expect to make money. If you had $50,000, you could only buy 1000 shares of Walgreens. Took same amount of money you could buy 13,440 shares of Rite Aid. If it goes up a dollar you just made 13,440 dollars. If Walgreens goes up a dollar you just made 1,000 dollars. Do the math. Rite Aid has a lot more room to grow than Walgreens. Walgreens is starting to accumulate more debt. With their expansion and their dividend payment which is considered a liability not an asset. Both of these are coming out with earnings in less than 2 weeks we will see who is right and wrong.

  • Report this Comment On September 12, 2013, at 12:09 PM, prginww wrote:

    Rite Aid does not need sales growth because their price/sales ratio is fractional compared to CVS and WAG. They only need improved efficiency in order to trade higher. Greater profits = higher stock for RAD

  • Report this Comment On September 12, 2013, at 12:23 PM, prginww wrote:

    Rite Aid and Walgreens have very little to work with in terms of growth. Walgreens has squeezed every bit it can out of its pharmacy operations and its workers. IMO, execs should have been given the heave ho when that mess with Express Scripts hit the fan. Ever walk into a Walgreens guys? It's mega expensive for items not on sale. What is killing retail pharmacy? The front end. Front end items marked up so ridiculously high they sit on shelves, in the backroom, in the warehouse wasting valuable shelf space and lowering turnover ratios. Price the items at a fair or sale price, get more foot traffic in your stores and make your sales. Rite Aid, personal experience here, that crapfest of a company should be investigated for fraud (massive fraud). Again, they too are running very tight with their pharmacy (little or no raises, hiring overseas pharmacists, overworking and hostile work environments). Lots of lawsuits coming in for that. Something is going on in Camp Hill and it is huge but not good news. Look into it while I call the DEA on them.

  • Report this Comment On September 12, 2013, at 12:31 PM, prginww wrote:

    One more thing, a CVS exec in a conference call admitted that the front end sales account for only 15% of sales. This is what's wrong with all the chains, CVS, WAG, RAD. So much building space devoted to front end but the front end is not promoted, not developed by corporate, staffed with minimum wage, don't feel like being here employees. Keep cutting the hours for the front end and keep driving your FE sales down while expecting pharmacy to pick up the slack. CVS will always have a high stock value but they are driving their company slowly into the ground with their Caremark division and their never ending implementation of time wasting metrics, harassing phone calls to customers and antiquated inventory methods like waiting bin inventory (a physical scan of inventory once a month which should not happen if your software has JIT or a perpetual inventory program in it). Their pharmacy software crashes several times a year sometimes for a day at a time due to "updates" losing millions a day in lost sales.

  • Report this Comment On September 13, 2013, at 1:54 PM, prginww wrote:

    @bestinsiderinfo: I wasn't aware of that comment from CVS, but that's probably including the Caremark PBM subsidiary. For WAG and RAD (which are more pure play drugstores), front-end sales are higher: low 30% range for RAD and mid-high 30% range for WAG.

    High-low pricing is the name of the game for most retailers. There are some retailers that have been very successful with everyday low prices, like Wal-Mart, Target, Costco, etc., but for the most part retailers prefer to have high prices so they can create big markdowns to drive traffic. That's exactly what WAG is trying to do.

    @BrianNichols: Your comment assumes that RAD can continue improving margins. I don't think that's the case. The margin growth that occurred last year was an artifact of the Walgreen-Express Scripts dispute and a surge in generic drugs. As customers continue to filter back to Walgreens stores and PBMs keep cutting reimbursement rates, drugstore margins will be squeezed. WAG can better operate in that kind of environment because it has much better margins to begin with.

    @masterwallstreet: Rite Aid is not growing; it is shrinking. Walgreen is growing. Moreover, Walgreen has approximately the same valuation as Rite Aid on a P/E basis, but is much more stable financially.


  • Report this Comment On September 15, 2013, at 12:07 PM, prginww wrote:

    Proper usage of the company name is either Walgreen Co or Walgreens. This is exemplified all over their website and in their press releases and other official communication.

  • Report this Comment On September 18, 2013, at 11:42 AM, prginww wrote:

    The 15% comment is actually from an interview with Merlo this past year. It is also found in a slide show presentation I saw on the web. It's a shame too, because CVS has such resources and lets the front end die a miserable death with its less than stellar staffing hours and sales. This company's stocks could be in the 70 dollar range per share if the lead management would actually do something rather than let the Caremark side dictate what to do. That is a very real problem that Merlo hasn't dealt with at all.

  • Report this Comment On September 20, 2013, at 4:33 PM, prginww wrote:

    Off topic but an interesting note is the FDA ban of 50% of all generic drugs made by Ranbaxy due to adulteration. I know for a fact that Rite Aid and CVS use Ranbaxy quite a bit for their generics. Ranbaxy being owned by Daiichi Sankyo, the manufacturer of drugs like Benicar and Welchol. It would be nice to see an all American company take advantage of this situation and step up and provide much needed jobs here. Ranbaxy generics are everything from generic Lipitor, Xanax, pain pills, metformin etc. That is a lot of product to try to find substitutions for in a short period of time.

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