It’s been awhile since we last looked at the drugstore and pharmacy retail category, but the extra time has given us the ability to better assess how the category is doing as it deals with a number of concurrent trends, including the inflationary headwinds, a decrease in visits related to COVID vaccines, and a shift in visits as the key players in the category–Walgreens and CVS–continue to optimize their store footprint by closing redundant legacy format stores in certain markets and emphasize new primary care retail options.
With CVS’ Q2 2023 update this week, we thought we’d revisit the category, starting with a comparison of visitation trends across consumer staples retail categories. Drugstores and pharmacies have been the weakest performing category among non-discretionary retailers this year (below).
This underperformance can be partly explained by store closures. On its fiscal Q3 2023 update at the end of June, Walgreens announced plans to close an additional 150 stores in the U.S. by the end of fiscal 2024 (September 2024), on top of more than 450 locations that have been closed since late 2021 (Walgreens’ U.S. store count stood at a little more than 8,700 locations at the end of May). CVS remains committed to closing 300 stores per year from 2022-2024 compared to its current U.S. store base of 9,500 locations. However, to normalize for store closures, we’ve presented visit per location data for the two chains below, which indicates year-over-year declines. For the most recent quarter, CVS reported that its comparable store sales for its pharmacy business grew 11%, but largely due to impact of its pharmacy drug mix, increased number of prescriptions, and inflation. However, front store comparable sales declined 0.3% due to fewer OTC COVID test kit sales (excluding test kits, CVS comparable store sales increased 1%). We believe the reduction in COVID vaccination visits and OTC test kit demand explains a large portion of the year-over-year declines in visits per location, although year-to-date visits per location are trending below pre-pandemic levels.
At the end of the day, the deceleration in visits per location–which likely reflects increased competition from other non-discretionary retail categories including super store and dollar stores–is one of the reasons we believe that drugstores have prioritized healthcare specialized formats, including VillageMD for Walgreens and Oak Street Health for CVS. Last July, we presented Walgreens’ estimated economics for Village MD Clinics, which suggested a meaningful acceleration in sales and contribution margins as these clinics matured (below).
Despite ambitious goals for their primary healthcare formats, both Walgreens and CVS have faced challenges in attracting new patients to these locations. Below, we’ve presented visits per location for Village Medical, Oak Street Health, and One Medical (the primary healthcare provider that Amazon acquired last year), and while there have been some modest increases in visits per location for these formats, they have lagged the projections provided above (it’s worth noting that our visit per location estimates only include standalone locations, and not co-located clinics. Walgreens noted that roughly 50% of patients at co-located Village MD clinics are getting prescriptions filled at Walgreens, demonstrating the cross-visitation synergies between its pharmacy and primary health formats).
Acknowledging the challenges in attracting new patients, Walgreens has slowed the pace of Village MD clinic openings in new markets and refocused its efforts on existing locations to drive more profitable growth. In addition to more localized economies of scale, the company is expanding its assortment of virtual and asset-light models and allocated more capital toward marketing to drive new patient acquisition. However, Walgreens management noted that it has achieved an appropriate level of market density in more mature Medicare Advantage markets like Arizona, Georgia, and Texas (our data indicates meaningful increases in year-over-year visits for its Georgia and Texas locations).
On this week’s quarterly update, CVS noted that Oak Street Health is accelerating patient growth through its “broad community presence and ability to engage consumers across multiple channels”, noting that there are approximately 1 million Medicare eligible seniors who visit CVS Pharmacies each week that are located near an Oak Street clinic. CVS plans to have Oak Street clinics in 25 states by the end of 2023 (up from 21 at the close of the transaction) while also opening new Oak Street clinics co-located with CVS Pharmacies, with plans to build 50-60 clinics next year.