Cornering The Market
Needs-based CVS is resilient during a recession. The company is continuing its path of acquisitions and new store openings. Here’s how this dynamic retailer plans to corner the market over the next few years.
Randall Shearin

Over the past 6 years, CVS has developed an average of more than 250 new and relocation store projects per year.

Over the last 20 years, CVS/pharmacy has gone from a regional retailer with 750 stores to become the nation’s largest pharmacy retailer, with more than 6,900 stores in 41 states. The company has grown its presence with an aggressive development program, acquisitions of chains and individual stores, and through acquiring or merging with related businesses.

CVS is in a category that is resilient in any economy. It is a needs-based retailer, and one that provides a healthcare service to customers, as well as convenience retail. The company is also continuing to expand during these times, for the right reasons.

Shopping Center Business recently visited the headquarters of CVS Caremark Corporation, parent company of CVS/pharmacy, in Woonsocket, Rhode Island, to meet with executives in charge of real estate. While there, we met with Doug Sgarro, who serves as president of CVS Realty Co., as well as executive vice president and chief legal officer of CVS Caremark Corp.; Dino DeThomas, senior vice president of CVS Realty Co.; Charley Golden, vice president of construction and property administration for CVS Realty Co.; and Robert Marcello, vice president of finance for CVS Realty Co.

CVS/pharmacy is only one division of CVS Caremark Corp. CVS/pharmacy is the store and retail pharmacy operation of the company. The other division is Caremark Pharmacy Services, which operates a pharmacy benefits management business.

Past And Present

The first Consumer Value Stores — CVS — location in Lowell, Massachusetts, circa 1963. The stores began adding pharmacies in 1967.

CVS started in 1963 as a single store selling health and beauty products in Lowell, Massachusetts. CVS — originally named Consumer Value Stores — was founded by brothers Sidney and Stanley Goldstein. Stanley Goldstein remained a part of CVS and related entities until 1999. CVS has been growing since it opened its first store; after a year in business, the company had 17 stores. In 1967, the company began adding pharmacies into its stores. In 1969, CVS was sold to Melville Corporation, a retail conglomerate that grew to include such retailers as Marshalls, Linens ‘n Things, Thom McAn and KB Toys. By 1980, CVS had more than 400 stores and was the 15th largest pharmacy chain in the U.S. By 1988, the company had 750 stores. In 1996, the Melville Corporation was restructured, and CVS became a separate company. Co-founder Stanley Goldstein served as chairman of CVS.

Consumers began taking note of CVS as a national chain in 1997, after the company doubled its size by acquiring the 2,500-store Revco chain and re-branded the stores as CVS shortly thereafter. The next year, the company acquired the 200-store Arbor Drugs chain in Michigan. All the while, CVS/pharmacy had been steadily developing stores. By the end of the 1990s, the company had more than 4,000 stores. In 2000, the company opened its first stores in Chicago and Florida. In 2002, the company expanded its footprint to Texas, Arizona and Nevada. The company crossed the 5,000-store mark in 2004 with its acquisition of more than 1,200 Eckerd drugstores from J.C. Penney. The Eckerd transaction provided CVS with a large critical mass of well-located drugstores in Florida and Texas. In 2006, the company acquired approximately 700 drugstores operating under the Osco and Sav-on banners from the Albertsons supermarket chain, providing CVS with a leading market share in Southern California while bolstering its presence in other key markets like Chicago. Most recently, in 2008, the company acquired Longs Drugs, picking up more than 500 stores in Nevada, Arizona, California and Hawaii. The acquisition resulted in CVS having more than 800 drugstores in California (more than any other retailer) as well as the leading market share in Hawaii. Along the way, there have been other acquisitions and a steady stream of organic development, taking the company to nearly 7,000 stores in 41 states today.

CVS Caremark Corporation is more than a drugstore chain. In 2007, CVS merged with Caremark Rx., Inc, creating the largest pharmacy services company in the world with revenues expected to approximate $100 billion in 2009. Today, CVS Caremark is the largest provider of prescriptions in the nation, filling or managing more than 1 billion prescriptions per year. The company is uniquely positioned to effectively manage drug costs and improve healthcare outcomes through its nearly 7,000 CVS/pharmacy drugstores; its Caremark Pharmacy Services division (which provides pharmacy benefit management, mail order and specialty pharmacy services); its retail-based health clinic subsidiary, MinuteClinic; and its on-line pharmacy, cvs.com.

“Tom Ryan [CVS Caremark’s Chairman, President and CEO] and the management team realized early on that there was value in growing our company,” says Sgarro. “We needed to grow our network of stores to enhance our ability to service our customers and realize operating efficiencies. It became apparent 10 to 15 years ago that consolidation in the retail pharmacy sector was inevitable and at that point our management team made the decision to be an acquirer rather than be acquired.”

Doug Sgarro, president of CVS Realty Co., and executive vice president and chief legal officer of CVS Caremark Corp.

Sgarro joined CVS in September 1997, shortly after the Revco acquisition, following a 13-year career as a partner in a large Wall Street law firm. During his 11 years at CVS, Sgarro has worn many hats. In addition to serving as CVS Caremark’s chief legal officer and president of CVS Realty, Sgarro currently has oversight responsibility for corporate compliance and government affairs and co-chairs the company’s strategic planning and corporate development efforts. An experienced mergers-and-acquisitions lawyer, he led the company’s deal teams in the Arbor, Eckerd, Osco/Sav-on and Longs acquisitions, as well as the Caremark merger.

CVS Realty Co.

CVS/pharmacy’s real estate operations are handled by an unincorporated operating division called CVS Realty Co., which acts as a full-service, in-house development company.

“We like to think of CVS Realty Co. as a fully integrated development company,” says Sgarro. “We have site selection expertise, but we also have considerable construction and architectural expertise, as well as facilities management and real estate finance capabilities. We’re investing an enormous amount of capital in real estate. Having this level of expertise in-house ensures we have full control of the store delivery process.”

In addition to the company’s strong acquisition program, CVS/pharmacy has had an aggressive new store delivery program for the past 10 years. Over the past 6 years, the company has developed an average of more than 250 new and relocation store projects per year. CVS also acquires about 250 prescription files from independent pharmacies per year, in addition to the large acquisitions it has made — like the Longs Drugs stores in 2008. All of the acquired stores (with the exception of Longs’ Hawaii locations) must be re-branded to CVS/pharmacy and the acquired real estate must be evaluated closely for relocation possibilities.

“Real estate is very much a team effort here,” says Sgarro. “We partner very closely with the operations team. We have a great team of site selectors, construction people, project managers and architects. In addition, we also have excellent alliances with the development, brokerage and construction communities.”

CVS Realty not only handles the development of new stores, but the relocation of existing stores and acquired locations. For instance, after the company acquired a portfolio of Eckerd stores, it relocated some to better positions within their markets. It generally relocates stores as their leases expire, moving inline locations to freestanding sites. The company will also handle the re-branding of acquired locations, working in tandem with CVS’s operations and merchandising departments. Through its finance department, CVS Realty also handles the sale-leaseback of its newly developed locations, and handles excess real estate as well. Maintenance and repair of all stores also falls under CVS Realty’s duties. For a company with nearly 7,000 stores, this is no small task and CVS Realty has more than 200 employees.

There is not a lot of turnover at CVS Realty. DeThomas, who leads national site selection efforts, has been with the company for 30 years. One vice president retired last year after 38 years. Others have been at the company for decades. Many have joined CVS after being “acquired” along with stores. Several in the real estate division [as well as Larry Merlo, the president of CVS/pharmacy] came through the acquisition of other drug store chains. Since real estate works closely with CVS’s operations division, most vacancies in real estate are filled by internal candidates with operations experience. CVS generally tries to fill positions internally before looking outside the company. However, a number of real estate employees have experience with other large retailers, like McDonalds, Dunkin’ Brands and Starbucks Coffee.

Regional real estate vice presidents, real estate directors and construction personnel are located at regional offices across the U.S. DeThomas thinks it is imperative that real estate directors, who act as the company’s dealmakers, live in the markets.

“People have to understand the market,” he says. “They need to know the market so they can see where the traffic is as people are going about their normal routines. We still do real estate on the ground. We spend a lot of time driving around and talking with brokers about specific corners and locations.”

That philosophy has worked out well. DeThomas says few stores in the chain are underperformers. DeThomas can only recall one location that CVS has closed that it built from the ground up in his career.

Site Selection

CVS prefers a well-trafficked, four-corner intersection that has easy access from all four corners. While there should be substantial population in the trade area, demographics like average household income, college degrees and the like are not important to CVS — the retailer sells products that everyone needs, regardless of income or education. Instead, CVS does intensive market studies and decides how many stores can be supported in a particular market.

“Our trade areas can range from a few blocks to several miles” says DeThomas. “It depends on whether you are in a high density, urban market or a larger, more rural environment.”

CVS/pharmacy looks for convenience and location in seeking sites for its urban stores.

CVS looks for locations large enough so that the retailer can have convenient access, a drive through and have good visibility. There are two prototype locations, both of which are altered based on the individual site so that no two stores are the same. Each of the prototypes has three different sizes. The prototypes vary between 11,500 and 13,000 square feet. The site must also contain enough area for 60 or more parking spaces. There are also two prototypical architectural styles to the stores.

“We tailor our sites to the area,” says DeThomas. “You are not going to get a freestanding location inside the Loop in Chicago, or in a metropolitan downtown, so we have to tailor our store size and layout to fit the best sites that are available to us.”

CVS Realty has approximately 25 real estate meetings a year — roughly two per month — to decide on new locations. At each meeting, the CVS real estate committee (comprised of Ryan, Merlo and Sgarro) is deciding on 15 to 25 deals. The day after Shopping Center Business visited, the committee was scheduled to decide on 17 new locations at its real estate meeting.

“The retail real estate community knows that we are very selective about real estate,” adds Sgarro. “We are insistent on having high quality locations. We don’t just open stores for the sake of growth.”

Relocations are driven by economics. CVS tends to wait until it gets close to lease renewal before leaving an existing inline location but will occasionally relocate stores with a significant amount of remaining term. In those instances, CVS Realty’s surplus property team will sublease the existing location to a new tenant in order to mitigate rental expense. Where possible, CVS will leave inline locations for freestanding locations where it can have a drive-thru. Generally, a relocated store is sited within 3 miles of the existing store. Sales volume and rents also drive the company’s decisions.

“It is difficult to justify leaving a location where you are paying $4 per square foot in rent to pay significantly more for a newly constructed site. There has to be compelling opportunity to increase sales significantly and provide our customers more convenience,” says DeThomas.

The company’s real estate analysts complete a review of every store during the first quarter of every year. Operations and real estate, including the development team, go store-by-store through the analysis, which is organized by which leases are coming due first. The analysts also put together a demographics and competitive market study package for every potential location that dealmakers have sited. The analysis gives the real estate department defined goals up to 5 years on priority relocations or lease renewals. CVS begins looking early for locations. In some markets, it has banked land for future development.

“There are pluses and minuses to owning land for development in the future,” says DeThomas. “The pluses are that there is a lot more land available now and the prices are more reasonable than in the past. The minuses, of course, are that you don’t know how long it’s going to take for enough housing to be built to create sufficient demand. We’re being cautious on buying land for future developments, but we’re not passing any good opportunities by.”

CVS/pharmacy operates in 41 states and Washington, D.C. It has stores in most states east of the Mississippi. The missing points are the Rocky Mountain states like Colorado, Wyoming, Idaho and Utah, and the Pacific Northwest. The company had expanded into California in the early 2000s, but the Longs Drugs and Albertson’s acquisitions over the last 2 years were a giant leap into the market.

“There is a lot for us to digest,” says DeThomas. “We have acquired more than 700 stores in the last 3 years in California. We’ve expanded our footprint and have room to grow within that footprint.”

In 2009, CVS/pharmacy plans to open 250 to 300 stores. Of those, 150 to 175 will be new locations and the rest will be relocations from existing stores.

“If you had asked us 10 years ago what store portfolios we’d like to acquire, we would have said that we would like to get our hands on the Eckerd Florida and Texas portfolio, which ultimately we did,” says Sgarro. “I think we would have also aspired to have the Osco/Sav-On portfolio in Southern California and the Midwest. Lastly, the Longs Drugs portfolio in Central and Northern California would have looked pretty good to us as well. It is fortuitous that, over time, we were able to get all of those deals done and fill out our footprint with quality real estate that we’ve invested in and that we can grow over time.”

Development And Sale-Leaseback Programs

For its ground-up developments, CVS prefers to do fee development. It has relationships with a national network of preferred developers. It pays its preferred developers a fixed fee to develop a CVS store. CVS funds the project cost of stores developed through its preferred developer program and warehouses these projects on its balance sheet. Later, CVS will monetize the properties in the institutional sale-leaseback market. This enables CVS to redeploy its capital into its core business while mitigating occupancy costs.

“We outlay capital to develop stores then, through sale-leaseback, we’re able to get our capital back so we’re constantly putting the money back into the business,” says Marcello. “If we were to own all locations, we’d have to fund development through short or long-term financing. By locking the lease down, we know that our expenses on every store will be fixed.”

CVS is able to efficiently finance its stores as well, since it has one of the best credit ratings among retailers. With a CVS Caremark corporate guarantee behind the lease, the property buyer can rest easy that the property has a secure tenant. That drives down cap rates, making CVS’s rent lower in the long run when compared to the rental expense it would incur through traditional turnkey development.

“The sale-leaseback program really allows us to leverage the strength of our balance sheet,” says Sgarro. “One of the reasons the institutional market has an appetite for these boxes is because it knows we have strong credit.”

CVS Realty has six regional development teams across the country. Each team is headed by a regional vice president of real estate. The teams are scouting for sites and actively developing new locations. Each team has three to five regional directors of real estate that handle a smaller geographic region. These are the dealmakers. Each team also has construction project managers and an area director of construction along with dedicated regional real estate attorneys. Each group also has a team of third-party preferred developers that they work with.

“We, along with our preferred developers, act as our own developer,” says DeThomas. “Our expansion at CVS is driven by our operations department. Internally, they are our biggest partner in the real estate development program.”

Preferred developers have a set geographic territory so they are not bidding against each other for business.

CVS prefers to buy the land where a store will be located. Its second preference is to do a ground lease. It will also do a build-to-suit location if it can’t get its first two preferences. About 50 percent of new locations are built on land that CVS owns. Most of the deals the company does with shopping center developers are for pad sites; most of the stores in shopping centers are leftover from acquisitions.

“We really look for the freestanding convenience and strive to have the best drug store location for the trade area,” says DeThomas.

Construction And Conversion

Charley Golden, vice president of construction and property administration for CVS Realty Co.

Golden joined CVS 13 years ago, at a time when the company was migrating from doing its own turnkey development on stores to hiring developers to build its stores. The industry was in the process of building freestanding stores. It was a changing time for CVS. Rather than rely on landlords, it had to put up its own money for development, then sell the stores in sale-leaseback.

“It was a real change for the organization,” says Golden. “We had to make a lot of philosophical changes in the company. We couldn’t wait until a project was ready to be built; we had to participate in the project’s development on the front end. Our project managers had to switch from being more superintendent-oriented to being overall construction development managers.”

CVS Realty had to add a lot of new skill sets. As where the company was used to building out inline stores, it had to hire people who knew the ins-and-outs of development. It had to learn more about signage — and the zoning that went along with it. And it also had to learn about access with freestanding locations — where the best places were to locate entrances and exits.

“We really had to change the style of the staff that we had,” says Golden. “The majority of our people were also located in New England. We were starting to spread our wings, so we had to decentralize construction and real estate management. Our staff is now housed with the operations staff in field offices. They all also live in the area where they are working. They’re building relationships and working with operations in the field.”

“Ten years ago, we were reliant on third-party developers to develop property for us,” adds Sgarro. “They would either develop a pad site for us or we would be a tenant in a shopping center. It was a leasing operation. Now, we take much more of an activist role. We are able to monitor our capital spend and deliver real estate more efficiently.”

Another area that Golden changed during his early years at the company was maintenance. The company used to outsource all maintenance management to a third party. CVS made this an in-house department so it could better control expenses. The company still uses vendors to perform maintenance work, but management is handled in-house. The maintenance call center receives about 400,000 calls per year from stores on various maintenance issues. Utilities management is another area Golden brought in-house. With many states deregulating energy providers in the late 1990s, CVS began contracting with providers in many areas to save money. CVS has an energy management system installed in all new stores so that it can control HVAC operation from a remote location.

A MinuteClinic unit within a CVS/pharmacy location. CVS Realty, the company’s real estate division, is also responsible for locating and constructing MinuteClinic locations within CVS stores.

In more recent years, the acquisition of MinuteClinic by CVS Caremark has given Golden’s group a heavy charge. The division is responsible for adding MinuteClinics into CVS/pharmacy locations as needed.

“As the organization has grown, we have become the overall construction division of the company,” says Golden. “Ten years ago we were developing or converting 300 to 400 stores per year, on a base of 4,000 stores. Today, we’re doing around 300 stores a year on a base of 7,000 stores. In addition, we are managing remodels, merchandising rollouts, pharmacy projects, construction of new business offices and even a new call center.”

Golden’s group is also in charge of facilities for the company’s Caremark Pharmacy Services division. It handles all areas of construction and maintenance for its offices, specialty pharmacies and call centers.

“The growth of the construction division has really mirrored the growth of CVS Caremark as a whole,” says Golden. “Ten years ago, we were a pharmacy retailer. Today, as a healthcare provider, we have everything from retail pharmacies to mail order facilities to call centers to MinuteClinics in our stores.”

Golden adds that CVS has never missed its goals for store delivery in any year.

In 2009, one of the construction team’s largest charges is to convert many of the Longs locations in the western U.S. to CVS/pharmacy stores. With such a large transaction, it is an unrealistic financial investment for CVS to gut every Longs store and replace it with new fixturing. Together with operations, the construction department figures out how to reuse as much of a store’s existing infrastructure as possible. If necessary, it will cut down the shelf heights. It will change the flooring and add CVS’s colors to the store. New signage will be added to bring CVS branding to every store.

“Our operations team has done a spectacular job in remerchandising the stores that we’ve acquired,” says Sgarro. “If you look at the Eckerd portfolio, for example, we were able to turnaround all of the locations with our merchandising plan and field management team. We implemented our work processes and greatly improved the quality of service and the overall retail presentation. As a consequence of that, the stores’ performance has improved dramatically.”

In Hawaii, where CVS/pharmacy is the Number 1 drugstore since it acquired Longs, it will hold off converting the stores since the Longs Drugs name is almost engrained in the state’s retail culture. The Hawaiian stores are also larger than a typical CVS and carry more general merchandise.

CVS did an interesting exercise in 2008. Using an old Longs store that it had closed, CVS’s construction and operations teams blacked out the windows and created the prototype of what the interior of a converted location would look like. CVS added graphics, changed shelf heights, went as far as adding the POS equipment and putting products on the shelf. The store became known as the “Alpha Store” and became the model on which all conversions will be based. The model was based on knowledge at hand, rather than computer aided drawings, as a converted store would be. CVS was also challenged in that it was working with fixtures that another company had specified, so it knew adjustment would be needed. The Alpha Store gave teams the opportunity to review their decisions before implementing them across nearly 500 locations.

“The Alpha Store was a giant pilot plant for our merchandising teams and managers to go in and see what the converted stores would look like,” says Golden. “We could then take their feedback and adjust the model as needed. It allowed our merchants and operators to touch and feel the ideas everyone had. It also allowed for open discussions on costs and savings. It was a giant sandbox for everyone to play in with no penalties. Once we all agreed, we created a move forward plan.”

CVS is now moving forward with its Beta store conversions of Longs — taking ideas from the Alpha store and implementing them. Once that program is up and running, CVS will be converting up to 25 Longs Drugs stores per week to CVS/pharmacy locations. Golden anticipates all stores — with exception of Hawaii locations — will be converted by the end of the year.

Look

Along with pharmacy and beauty, photo departments have become an integral part of CVS/pharmacy locations.

Just as important as what is on the outside of the store, is what is inside. There, location of the pharmacy, front register and other standards can vary based on specific location. The highest preferences are the store’s two biggest selling items — pharmacy and beauty products.

Conversions of acquired stores are a big part of the construction team’s business. When CVS acquired Revco, it didn’t leave the stores with the same look. In some cases, this meant removing the façade and adding one of CVS/pharmacy’s standard looks.

“If it is a facility that we know we are going to stay in, we will reinvest the money and do a exterior refresh of the store,” says Golden. “When we get done, the exterior of the location will look just like a new store.”

The bigger challenge comes when CVS acquires urban stores. The interior is mostly what matters here; shelves must be tailored to CVS’s standard heights. CVS is very particular that customers be able to see everything in the store and have a clear sight line to the pharmacy.

“No two stores come in the same size,” says Golden. “The size of the structure limits the amount of product that we can display. In urban locations, it is really a function of the size of the property that’s available to us. You are really taking your merchandising layout and implementing it to the size of the space.”

Finance

Robert Marcello, vice president of finance for CVS Realty Co.

The real estate finance area of CVS Realty is led by Marcello, a 14-year CVS veteran. Finance handles a number of aspects, including the sale-leaseback program, excess real estate disposition, lease administration, market research, property taxes and budgeting and forecasting.

The sale-leaseback program is one of the biggest operations of real estate finance. About 75 percent of CVS/pharmacy locations are done under sale-leaseback. Since CVS purchases its own land and builds its own stores, it is the owner of the store after it is complete. Typically, CVS pools a critical mass of locations ($300 to $500 million) and sells them in the institutional sale-leaseback market. Some go to 1031 buyers, while others go to larger investors. CVS then leases back the store and land (in a triple-net lease) for a period of 75 years. This allows the company to control its real estate costs, yet retain all rights of ownership. It can make improvements to the store, change signage and even sublet the space if it chooses to relocate.

CVS has held a number of landmark locations in a portfolio. For instance, the company owns its store on the Las Vegas strip. It owns other stores in high demand markets, like Los Angeles and Boston. Marcello estimates that the company only owns 3 to 4 percent of its stores.

Because the market for triple-net leased properties has slowed, CVS is looking at alternative structures to finance its stores.

CVS Realty has a sophisticated market research group. The group uses proprietary software to analyze demographics and competitive variables. The analysis is provided to the real estate and operational team to assist in identifying prime locations. The analysts also perform spatial modeling which, together with on the ground research, determines where CVS positions its store network within a market.

Surplus real estate is created through CVS’s store relocations, acquisition overlap and excess space in existing locations. Mostly, the company has been shedding inline locations for freestanding corner stores. Typically, it is left with a short period of time on the lease. It generally has two alternatives in this scenario. The first is to sublet the space. The second is to settle with the landlord and terminate the lease. These days, with many landlords looking at only a short amount of the term left on the lease and their own cash flows constrained, many are opting for a settlement. CVS will generally only accept these terms if they are feasible for the company and if it is let out of its agreements to maintain the premises.

“If it is economically efficient, we will move toward a settlement with the landlord,” says Marcello.

If it can’t, the company will sublease the space to another tenant. In addition to two full-time employees, CVS uses third-party companies to handle its excess real estate to mitigate its liabilities. The company also maintains a web site for its surplus opportunities at http://www.cvscaremarkrealty.com/surplus-properties. The company currently has more than 300 sub-tenants that it deals with. CVS sublets about 40 to 50 stores per year — more than many retailers even have in their chains.

“Even inline, our locations are good,” says Marcello. “Our second generation space is also not that expensive because the leases are generally older. It’s attractive for many tenants. The sites generally sell themselves. If it is a decent site with a low rent, we are getting calls on it.”

Surplus property also includes some smaller shop space built adjacent to CVS. Some locations are large enough that they can be subdivided as well.

“Even in a 9,000-square-foot location that we’re leaving can be divided to sublet to smaller operators, like coffee retailers, telecommunications providers and quick service operators. We generally have enough frontage that we can make several 2,500-square-foot spaces.”

Along For The Growth Dino DeThomas, senior vice president of CVS Realty Co. Dino DeThomas, senior vice president of CVS Realty Co., is a 30-year veteran of the company, who started as a store assistant manager as part of CVS’s management training program. Later, he helped start the company’s pharmacy acquisitions team, seeking independent pharmacies for CVS to acquire. In 1992, he became director of real estate for New England, as well as director of acquisitions. In 1997, DeThomas was made vice president of real estate after the purchase of Revco and relocated to Ohio, where Revco’s operations were. In 2001, DeThomas assumed new market development for CVS and rejoined headquarters. There, he led the company’s entry into new markets, like Chicago, Florida, Texas, Arizona and Nevada. Shortly after CVS acquired Eckerd, DeThomas was made senior vice president of real estate development and acquisitions.

©2009 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.