By all accounts, 2014 was a breakthrough year for Rite Aid (NYSE: RAD), and by extension, owners of Rite Aid net leased pharmacies. After struggling for over a decade with structural weaknesses in its business, ranging from accounting scandals to poor acquisitions, the company is finally managing to turn around its operations. All the while making some landlords very, very happy.
Started in Pennsylvania in 1962, Rite Aid became a strong regional chain under its founder, Alex Grass. Alex handed over the reins to his son Martin Grass in 1995, and four years later the company was implicated in a $1 billion accounting scandal. Its debt plummeted from investment grade to junk status in one day. Predictably, cap rates for Rite Aid properties spiked, and throughout the early 2000s, traded higher than CVS and Walgreens.
Beneath the turmoil lay other issues. Unlike its competitors, Rite Aid curtailed new store development, which caused its revenue growth to lag. In an attempt to expand, it acquired the Brooks and Eckerd pharmacy stores from Jean Coutu Group in 2006. The acquisition proved difficult, as expected synergies did not materialize and integration of the company became problematic, leaving Rite Aid heavily indebted and underperforming.
By 2008, weak financial results combined with a severe economic downturn caused investors to panic. Cap rates for Rite Aid properties surged, and at one point, Rite Aid's stock traded for as low as $0.28 (reference cap rate and stock price graphs at the end of this article).
It is very rare for a company so close to collapse to recover, even more so through a genuine improvement in fundamentals. But since its dark post-recession days, Rite Aid has undertaken serious changes. CEO John Standley and CFO Frank Vitrano, both hired in 2008, have injected fresh thinking into the executive team and helped integrate Rite Aid's acquisitions. The company launched Wellness+, a customer acquisition and retention program that is proving successful. Same store sales are up.
Perhaps most relevant to real estate, the company has shifted to a “net relocation” store development model. Instead of developing new stores, which carries high risk, Rite Aid simply moves existing stores to a larger location nearby (going from 6,000-9,000 SF to 14,500 SF). As a result, it is able to carry and sell more non-pharmacy products while keeping a similar roster of customers, improving profitability.
The result of these efforts is apparent. Rite Aid posted a $378.5 million loss for FY 2012, a $107.5 million profit for FY 2013, and a $220.9 million profit for FY 2014. Combined with a vibrant net lease pharmacy sector, it is easy to see why the tenant is experiencing such a dramatic cap rate compression within the investment community.
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Jonathan Hipp
Jonathan Hipp began his career in real estate over 25 years ago. In his early years as a broker, he ventured into the net lease industry and quickly began leading the US net lease market, closing over $3 billion in transactions. In 2005, Jon founded Calkain Companies, a company focused solely on net lease investment services. As President and CEO, he has been instrumental in building the firm into one of the leading Net Lease real estate companies, transacting over $12 billion of net lease deal volume over the past 13 years. He has expanded Calkain’s services to include brokerage, advisory, asset management, capital markets, and industry research. He has become a well-known resource, panelist, and speaker at various Net Lease and Industry conferences and is a regular contributor to GlobeSt.com on real estate trends. In June 2015, Jon’s passion for the real estate business was again recognized as he was nominated for the Top Real Estate Player in the DC area by SmartCEO magazine.
