Rite Aid Team Seeks Prescription for Growth
Rite Aid Corp. may finally be getting it rite.
The drugstore chain nearly collapsed in the late 1990s under the strain of massive debts, billion-dollar losses, an accounting scandal and poorly executed acquisitions, particularly its 1996 purchase of the Thrifty Payless chain, though that did make Rite Aid a major player in Southern California.
Now the management team recruited three years ago to save Rite Aid is showing results.
Debt is down sharply. Annual sales have risen $3 billion to $15.7 billion in its fiscal year ended March 1, even though Rite Aid has closed more than 400 stores.
Hundreds of the remaining stores have been remodeled. Credit and stock analysts are upgrading Rite Aid’s ratings, saying that product selection and service, once both lacking, are better. And Rite Aid’s prices, once deemed far too high, are more competitive.
The chain -- with 3,404 stores in 28 states, including 584 in California -- has significantly pared its losses, which totaled $4.1 billion in the last five years. In its latest fiscal fourth quarter, the Camp Hill, Pa.-based company eked out a $7-million profit.
The relatively new management team is led by Chairman Robert Miller and President Mary Sammons, who is set to become chief executive next month.
When they arrived in late 1999, “we really had our backs against the wall,” Miller said. “But we thought this was a viable business if we had enough time to turn it around.”
Rite Aid still faces a daunting future. Its debt, though lower, remains a burden. The chain must prove it can be consistently profitable. It trails rivals in some key categories, notably average sales per store. Rite Aid’s pharmacy business, which generates 60% of its sales, requires additional work to improve its sales and brand identity.
“Our No. 1 priority going forward is the pharmacy,” Sammons said.
There also is intense competition, especially in Southern California, where Rite Aid is up against Sav-on, the drugstore subsidiary of Albertson’s Inc., and Walnut Creek, Calif.-based Longs Drug Stores Corp.
Then there are the ever-louder footsteps of the industry’s giant, Walgreen Co., which is growing rapidly in the region.
“California is one of our top priorities,” said Jeffrey Rein, president of Walgreen, the nation’s largest drugstore chain by sales. “California is a very vibrant market, and we want to go where the money is.”
Walgreen opened its 4,000th store in March in Van Nuys. That gives it 90 full-size stores in Southern California, and Walgreen expects to open 50 more in the area in the next 18 months. (Walgreen also operates some pharmacy-only stores.)
And there is stiff competition from mass merchandisers such as Wal-Mart Stores Inc. and Target Corp. Not only do they have pharmacies, but they also have “really eaten into the health and beauty aids categories” that have provided stalwart sales for drugstores, said Diane Shand, a credit analyst with Standard & Poor’s Corp.
All those rivals boost consumers’ choices but exacerbate Rite Aid’s challenge. Just ask investors: Rite Aid’s stock, which hit $50 a share in early 1999 before the company imploded, closed Friday unchanged at $3.67 on the New York Stock Exchange. Still, the stock is up from a low of $1.65 reached in July.
On the plus side, Rite Aid and the nation’s 52,000 other drugstores are benefiting from the aging U.S. population. Prescriptions are expected to grow a stout 10% or more a year in dollar terms, analysts predict.
“We see lots of opportunity even with new competition moving in” to California, Miller said.
One of Rite Aid’s biggest stockholders is Leonard Green & Partners, a Los Angeles investment firm that owns about 12% of the retailer. Two of Green’s executives, Jonathan Sokoloff and John Danhakl, are on Rite Aid’s eight-member board.
“We think we now have the right balance sheet and the human capital to execute,” Sokoloff said. But the partnership has no illusions about an overnight fix. “We know this will be a long-term investment for us,” he added.
Miller and Sammons joined Rite Aid in late 1999 from Fred Meyer Inc., after that food and drug retailer was acquired by supermarket giant Kroger Co. They were startled to find that Rite Aid was in much worse shape than they had realized.
For starters, they learned that Rite Aid had overstated profits by $1.6 billion in the late 1990s. U.S. authorities alleged that Rite Aid’s former management had orchestrated a massive accounting fraud that rivaled the scandals that helped topple Enron Corp., Global Crossing Ltd. and Adelphia Communications Corp.
Last year, former Rite Aid Chief Executive Martin Grass and two other senior officers were indicted on criminal charges by a federal grand jury. The executives, who deny wrongdoing, are scheduled to stand trial in June.
Rite Aid reached a consent agreement with the Securities and Exchange Commission last year over the debacle. The chain, without admitting or denying wrongdoing, agreed to strengthen its accounting controls to satisfy the agency.
At the same time, Miller and Sammons had to overhaul Rite Aid’s flagging business and battered balance sheet. Besides refinancing debt, closing stores and remodeling others, they had to fix the way Rite Aid stockpiled and priced its products.
Previous management hadn’t allowed the stores to mark down old goods to clear them out, Sammons said. After polling employees, she said, she found that “they were frustrated at not having [new] products to sell the customer” and that they “were embarrassed by our pricing,” which was too high.
Miller and Sammons gave new orders: Get rid of it. Within months, about $300 million in old merchandise had been discounted and sold.
They also have had to work on improving workers’ morale and their service.
“What’s really going to set you apart is going to be the attitude of the people who work in the stores,” Sammons said.
There’s still much to be done.
Rite Aid’s gross profit margin -- before taxes, interest and depreciation -- equaled 6.7 cents per dollar of sales in its latest fiscal year, well below the 9.7 cents and 9.6 cents posted by Walgreen and CVS Corp., respectively, according to Shand of S&P.;
In the same year, Rite Aid’s same-store sales -- that is, sales of stores open at least a year, and a key gauge of retail strength -- rose 6.7% from the prior year. That was much better than three years ago, but the sales gain still trailed Walgreen’s 10.5% increase.
Many of the nation’s drugstores actually are two stores under the same roof. There’s the pharmacy business, and there’s the “front-end” store that sells housewares, cosmetics, groceries, stationery and the like.
Miller and Sammons intentionally focused on fixing the front end first, because “it’s more visible” to the consumer, Sammons said.
But now the drugstore industry “is going to be much more about the growth of the increasingly profitable pharmacy than the front end,” analyst Mark Husson of Merrill Lynch & Co. said in a recent report.
He said Rite Aid’s pharmacies still have an identity problem in the West. As Rite Aid converted Thrifty and Payless stores to Rite Aid stores, the Rite Aid name was “never positioned as a pharmacy leader and still does not mean much to many Californians,” he said in his report.
Sammons agreed that the Thrifty stores had focused on their front-end mass merchandise and “didn’t spend as much effort on the pharmacy side.” That won’t work today. Rite Aid is hiring new pharmacy executives, strengthening ties with managed-care companies and pushing a marketing campaign with the slogan “With us it’s personal,” to better promote the Rite Aid pharmacy brand.
Even so, industry executives noted that the pharmacy also feeds sales elsewhere in the store, which is why Rite Aid and its rivals are hustling to add more non-drug products such as groceries and inexpensive home furnishings.
“The average customer is only looking for 1.6 items when they come in, and they’re leaving with 3.1 to 3.3 items,” said Rein of Walgreen.
Convenience is crucial too. Many shoppers tend to keep going back to the same nearby pharmacy, picking up other drugstore items each time they fill prescriptions.
“Nearby” could mean a Rite Aid, Sav-on and Walgreen store all within the same driving distance, and that’s where the competitors’ brand identities, service, prices and selection will decide how much market share they garner.
But as long as Rite Aid is constrained by its heavy debt load, it will struggle to grow beyond its current size, said Shand of S&P.;
“Ultimately they’re going to have to start growing again,” she said.
Maybe. But “our salvation is not more stores,” said Sokoloff, the Rite Aid investor. “It’s making what we have better.”
