As Rite Aid's bankruptcy shutters drugstores, these retailers will benefit

Published Wed, Oct 18 20231:58 PM EDTUpdated Wed, Oct 18 20232:13 PM EDT

Rite Aid's bankruptcy is likely to be a bigger boost to retailers such as Walmart and Costco than it will be to other drugstore chains, according to UBS. And as drugstore closures accelerate, dollar stores may be able to scoop up some of the abandoned locations. "Broadly speaking, the retail environment has been pressured by many headwinds over the past handful of years, given the rise of eCommerce, Covid-induced supply and demand fluctuations, and higher costs to operate. … In our view, it may have been an even more challenging retail environment for drugstores than several other retail subsectors," Michael Lasser said in a recent note. He expects declines in the drugstore sector signal a growth opportunity for several traditional retailers looking to expand their health care and pharmaceutical offerings. Shoppers have already increasingly turned to these mass-market retailers for their everyday goods while searching for convenience and cheaper options — forcing drugstore chains to either pivot their business models or suffer. According to UBS, it's likely that there will be more nationwide drugstore closures over the next couple of years, as the beaten-down sector continues to struggle amid changing consumer habits and higher cost pressures. Drugstore chain Rite Aid filed for Chapter 11 bankruptcy protection on Sunday as it grapples with slowing sales, growing debt and lawsuits that allege the company contributed to the nation's opioid epidemic. The chain has closed about 225 stores since the end of its fiscal year 2021, according to the UBS note. In a bankruptcy filing Tuesday, Rite Aid said it plans to close 154 more locations. Rite Aid's bigger rivals, CVS Health and Walgreens , could also be facing existential threat even as the companies have pivoted to a health-care focus and made significant acquisitions in the space. Both chains have plans into next year to close hundreds of U.S. stores. One key factor has been the decline in so-called front-store sales, which includes items like makeup, shampoo and snacks. At all three drugstore chains — Rite Aid, CVS and Walgreens — front-store sales growth has lagged the pace of U.S. retail sales growth nearly every year over the past five years, Lasser said. A new growth story for traditional retail? According to UBS, major retailers Kroger , Walmart , Costco and Target could push further into the health-care sector, which was typically dominated by drugstore chains, and come out on top. Discount chains Dollar Tree and Dollar General could also benefit from drugstore closures. "The hardline, broadline and food retailers can leverage their size and scale, high trip frequency of their customers, investments in healthcare, and their broader product and service offerings (aka, one-stop-shop experience) to capture more share from the healthcare profit pool," Lasser wrote. "We believe their competitive value propositions (esp. in the front of the store) could also serve as a structural advantage in the long run." These retailers could win a greater share of prescription and front-store sales by offering products and services that are typically found at drugstores. Dollar stores, in particular, could also expand into store fronts once operated by drugstore chains. "We believe WMT, COST, and KR have an opportunity to further sweat their assets to generate greater sales productivity in pharmacy," Lasser wrote in the note. He estimates that Walmart, Costco and Kroger generated similar pharmacy sales per store in 2022, between $5 million and $6 million. That's below the $8 million in sales from CVS and $9 million from Walgreens. These retailers have full pharmacies, which will help them get a bigger boost when drugstores are closed nearby compared with retailers without pharmacies, the firm said. With a full pharmacy, retailers can offer more basic health-care services to consumers. Walmart is best-positioned within the mass market and food retail sector in terms of its location overlap, with 88% of CVS locations within a 15-minute drive from at least one Walmart store, according to a UBS analysis. How to play the trend Walmart is a loved retailer among Wall Street analysts. The stock has gained 14% so far this year, on par with the S & P 500, and is rated overweight by analysts on FactSet. Analysts, on average, have assigned a $179.11 price target on the big-box retailer, which indicates roughly 11% upside. Walmart had raised its full-year forecast in August, expecting net sales to increase by about 4% to 4.5%, after beating consensus expectations for fiscal second-quarter sales and earnings. In September, the retailer's chief financial officer said Walmart is beginning to see a slight pullback on food shopping among consumers taking weight loss and diabetes drugs like Wegovy and Ozempic. Costco shares have raced past the broader market this year, gaining 26% so far. The stock is rated overweight by analysts on FactSet, and its $595.25 average target price implies shares could add 3.7% over the next 12 months. Kroger shares, on the other hand, are basically flat for the year. The supermarket operator proposed a $24.6 million acquisition of Albertsons last October, and a year later the controversial merger is still waiting regulatory clearance. The companies expect they will need to sell more than 400 stores and other assets to address antitrust concerns. For dollar stores, the real advantage will be the real estate left behind. Drugstores are typically on corners in high traffic areas. The typical property size for standalone pharmacies tends to range between 10,000 and 15,000 square feet, while big-box retailers tend to occupy 50,000 to 150,000 square feet, according to Trepp research director Stephen Buschbom. "The standalone pad sites, from my perspective, are generally a really attractive option for the Dollar Tree and the Dollar General type of ... retailers to go in and backfill that space," Buschbom said. "Those retailers are going to be very, very aggressive in pursuing these opportunities since a lot of them have indicated what their expansion targets are — and this would seem like a ripe opportunity for them to do that very quickly." Dollar Tree and Dollar General shares have sunk into the red this year, losing about 19% and 53%, after seeing sales decline as customers became more selective with nonessential purchases. Still, Dollar General plans to open nearly 1,000 new stores this year. Both stocks have seen a better quarter, however. Shares of Dollar General were recently upgraded by HSBC and Gordon Haskett on optimism that the discount chain's new leadership could help stabilize the company. "For years, right, we've seen big-box retail getting chipped away at online sales … but the benefit that even budget Dollar Tree stores have is that their price point and the goods that they're selling are can be very difficult for Amazon to compete with," Buschbom said. "I think consumers are kind of waking up to that bad reality that Amazon is not always the lowest cost option."