Canada consolidate debt

Canada's drug chain industry witnessed tumultuous changes last year. After ushering in new management last June, front-runner Shoppers Drug Mart announced an initial public offering that would see it emerge just before year's end as one of the country's two publicly traded drug store companies. And, by that time, the Katz Group already had swallowed Canada's largest provider of services to independent drug stores, Drug Trading Co., upping its ranking to second place and fueling speculation that it would likely join Shoppers Drug Mart and regional heavyweight Jean Coutu Group on the stock exchange floor this year. For its part, Coutu was bolstering its presence in the United States, adding 80 of Osco's New England outlets to its Brooks' holdings.

And there's more heated activity ahead, say industry observers. Raising the specter of possibly three large publicly traded companies, together controlling about 2,100 units with combined system sales of about $10 billion, they're predicting that 2002 will see the continuing rollout of new business strategies aimed at driving sales, cutting operational costs and ensuring the type of growth that will create value for companies. This year also will see some intense competition as everyone jostles for positioning in Canada's drug store market, estimated at about $30 billion. And early in the year, Shoppers Drug Mart was already leading the pack.

Shoppers Drug Mart

With system sales up 10.2 percent to $5 billion from 827 drug stores and 37 Home Health Care stores in fiscal 2001, Shoppers Drug Mart moved into the new year committed to focusing exclusively on merchandise and operations to drive top-line growth and gain market share, according to new chairman and chief executive officer Glenn Murphy. Since taking the reins from David Bloom well over a year after the company was sold by its parent Imasco to an investment group led by Kohlberg, Kravis Roberts & Co., Murphy has moved swiftly to make his mark on the 40-year-old drug store retailer. Prior to joining Shoppers Drug Mart, Murphy was known for his retailing savvy at giant book retailer Chapters.

Along with a sizeable restructuring in its corporate offices, including numerous changes in senior management, Murphy engineered a redefined set of business objectives and guided the company through a successfully completed IPO in November. The IPO netted about $510 million from the sale of 30 million shares put on the market at an initial price of $18. (This, along with earnings from cash flow, was used to pay about $590 million in debt.) By early Shoppers' stock was trading at almost $22.

In its mission to create more value for the company, SDM continued with a strategy to target costs. According to Murphy, the new wide and aggressive approach to cost cutting and streamlining initiatives by Shoppers Drug Mart relies on "opportunities for acting as one company at store level." He also cited opportunities inside the business to "leverage our size and our continued growth in areas, such as cost of goods, and also some centralized services we provide within our business." With its state-of-the-art distribution centers, as well as centralized inventory and accounting systems introduced under massive restructuring in the late '90s, Shoppers Drug Mart is said to be well positioned to make these changes.

As part of its strategy to up volume and drive same-store sales, which grew 9.2 percent in 2001, Shoppers Drug Mart looked to bolster its customer base by offering more value. To shed its admittedly "convenience pricing" image, Shoppers Drug Mart reduced prices on about 1,500 front-store items, with plans under way to increase its competitiveness on everyday pricing, while upping the ante on weekly promotions. It also is credited the Optimum loyalty card program with boosting front-store sales in 2001 to $2.74 billion, up from $2.5 billion, and plans to use it as a promotional tool in its weekly fliers.

After operating the program for a full year, the company found that Optimum holders--numbered at 6 million--had higher unit sales and gross margin dollars per transaction. The program has a large role to play in Shoppers Drug Mart's business, according to Murphy.

Shoppers Drug Mart's growth strategy also hinges on updating older stores, while opening new free-standing and larger 10,000-square-foot to 12,000-square-foot units. Indeed a new stand-alone prototype slated for opening soon will run 12,000 square feet to 14,000 square feet and will be a test store for new merchandise concepts. At year's end, total drug store selling space was up 7 percent over the previous year at about 5.5 million square feet.

A recently announced capital expenditure program is expected to pump about $130 million--translating to $3.25 million per store--into developing about 40 new stores and relocating, expanding or renovating a number of others this year. This investment, as well as an earlier renovation project dating to 1998 that's seen almost 52 percent of the company's store base renovated or relocated, is critical to Shoppers Drug Mart's plans to up merchandise offerings to consumers.

In Vancouver, one new concept store is reportedly deep in food lines, and there's been increasing attention to seasonal. The company also plans to juice up its private label brands--Rialto, Life and Quo--with a relaunch by 2003. Murphy sees "significant opportunities" in private label sales, which traditionally offer higher margins, but currently account for only 10 percent of the company's front-end sales.

CIBC World Markets 2002 Investor's Guide suggested that the new pace marks the awakening of a sleeping giant by new ownership an d new management.

Katz Group

There's no indication though that the other heavy hitters in the drug store market last year were asleep at the switch. In fact, Katz Group's quick moves to grow its market share through unit growth landed the entrepreneurial Edmonton-based company a great prize last fall. The takeover of the venerable Drug Trading Co., the No. 1 supplier of services to independently owned drug stores, has added about 1,100 independent units to its already-established network of about 350 stores operating under Medicine Shoppe, Rexall, Pharma Plus and Herbie's/Payless. The move has upped its system sales to an estimated $4 billion in Canada alone. The company also operates Snyder's/Drug Emporium in the United States.

While there was early speculation about how many of Drug Trading's independent 1,100 affiliates, broken down as 750 banner stores under Drug Trading's IDA and Guardian names and another 350 linked to Drug Trading's computer system for buying and other purposes, would stay on board, Katz Group's chief executive officer Darryl Katz said that not only had most of the stores signed the new deal, but that the offer had actually enticed competing independents to the system. "Since the acquisition, we've moved very aggressively to provide more value-added services so that independents could prosper and we could expand the Drug Trading program," explained Katz.

The Drug Trading move follows Katz Group's strategy of building market share and adding "independent-driven" programs or systems to its portfolio. Alhough some industry players raised a brow, Katz said his company's "multibrand" approach, which sees various formats operating under a variety of names, opens up opportunities to "move strategically into various markets."

With chain acquisition prospects remaining dim in Canada, it's clear that Katz Group is eyeing the independent sector, which IMS Health reported as representing 25 percent of the market with about 1,782 units, compared with 58 percent of the market for chains and banner groups with 4,176 outlets. (The share of different classes of trade, however, differs across the industry depending on exclusion or inclusion of several large banner organizations).

According to Katz, the Drug Trading deal and any others that see independent networks linking with his company for services will not only strengthen the company by bolstering purchasing power and systemwide sales, but also will provide the type of "liquidity" today's independent needs to survive.

Katz said he would continue to tap the strengths of the Drug Trading system, which allows members flexibility to buy either through Katz Group or from "designated suppliers." Drug Trading will continue to provide services to the independent affiliates based on a service-fee system.

Katz Group has set up Katz Pharmacy Services to consolidate marketing, IT, finance and retail development for its corporate operations, notably the Pharma Plus and Rexall divisions. As of April 1, Norm Puhl moved from president of Pharma Plus to chairman and chief executive officer of KPS. Andrew Parkes, the former KPS vice president, is now president of Pharma Plus, and Barry Elliott is the new president of the 100-store Rexall operation.