Retail Pharmacy Update: Opportunities, Challenges, and Valuations
Prior to the pandemic, the retail pharmacy industry was experiencing significant disruption. We were witnessing a steady increase in transactions and consolidation, Amazon’s entry into the market, significant changes to strategic alliances between major payers and pharmacy benefit managers (PBMs), and the introduction of a wide array of new technologies, just to name a few noteworthy trends and developments. It’s safe to say that COVID-19 not only disrupted some of these disruptors, but it also brought with it new disruptors.
By understanding how the market is changing, retail pharmacies can determine how to best shift gears so they can remain viable and competitive in the coming years. To help you make more sound decisions concerning the future of your pharmacy, below are some thoughts on a wide range of current opportunities and challenges followed by an update on retail pharmacy valuation.
Retail Pharmacy Opportunities
These are some of the tailwinds for the retail industry.
Mobile apps — It’s never been easier or cheaper for retail pharmacies to offer and leverage mobile apps. Not only can an app make it easier for customers to refill prescriptions, get refill reminders, and take advantage of discounts, but providing customers with an app can enhance loyalty and improve satisfaction.
Mail order — Prior to the pandemic, mail-order prescriptions were on the decline. COVID-19 reversed this trend. Some consumers who used mail-order delivery for the first time or relied on it during the pandemic will revert to filling their prescriptions in person. However, other consumers who appreciated the convenience and potential perks of mail order will likely make it their default delivery method. Offering mail-order prescriptions can help you attract and retain these consumers and should prove appealing to potential new customers — including the growing number of people working from their homes.
Telehealth/telepharmacy — It’s safe to say that telehealth is not only here but it’s here to stay. Telehealth claim lines increased more than 2,800% (not a typo) nationally from December 2019 to December 2020, according to FAIR Health’s Monthly Telehealth Regional Tracker. Retail pharmacies that effectively leverage telehealth and telepharmacy can give their business a boost. While rules and regulations concerning the delivery of telepharmacy — including coverage — are evolving and vary from state to state, the addition of telepharmacy services can help pharmacies reach new patients and better support existing patients, all while improving patient care.
Digital pharmacy — For retail pharmacies looking to undertake a more dramatic overhaul, going the “digital pharmacy” route is an option. While there’s no clear consensus about how to define “digital pharmacy,” in this case, we’re referring to a pharmacy that significantly embraces digital technologies to deliver pharmacy services, such as mobile apps, telepharmacy, and online ordering.
Testing and vaccines — The pandemic has been a boon for those pharmacies offering COVID-19 testing and vaccines as these services not only generated revenue, but they brought consumers physically into stores. This presents an opportunity for pharmacies to sell products and educate consumers about available services, including the delivery of other screenings, vaccines, and immunizations. The trend also provides a pathway for retail pharmacies to pursue the conversion of retail space into clinics and primary care service locations. The expansion of pharmacy companies into primary care has driven “significant increases in both satisfaction and consumer spending,” according to the J.D. Power 2020 U.S. Pharmacy study.
Human experience and loyalty — Pharmacists remain one of the most trusted professions. This helps explain why some pharmacies are leaning much more heavily on their pharmacists. In October, Rite Aid indicated it was revamping the its business strategy and the layout of pharmacies to put pharmacists “front and center.” As Jocelyn Konrad, Rite Aid’s executive vice president and chief pharmacy officer, told Drug Store News, “We want to ultimately enable our pharmacists to address mind, body, and spirit of each of our customers, so that they don’t only get healthy, they get thriving.” Such initiatives that highlight the role and value of pharmacists while emphasizing the critical services they provide can help retail pharmacies remind consumers about the importance of a human experience for health and wellness. This can drive better outcomes and build consumer loyalty to the pharmacist and their pharmacy.
Customer base — While competition for customers is and will remain fierce, the good news for retail pharmacies is that their number of potential customers and the services required by customers is on the rise. This is fueled largely by the prevalence and increase of chronic diseases and an aging population. On a per capita basis, health spending has increased over 31-fold in the last four decades, from $353 per person in 1970 to $11,582 in 2019.
In addition, the pandemic has brought a new patient population into pharmacies: those who postponed receiving care as part of their efforts to reduce the amount of time spent outside of their homes. Subsequently, many of these individuals saw their health worsen. Some have chosen pharmacies as the first place to begin catching up on their neglected care. Pharmacists who effectively support patients as they restart their care journey can earn the loyalty that generates ongoing business.
Medicaid enrollment rising — As the Kaiser Family Foundation (KFF) reported, enrollment in Medicaid has soared during the pandemic. This will help bring new business to retail pharmacies because, as KFF also notes, “A large body of research shows that Medicaid beneficiaries have far better access to care than the uninsured and are less likely to postpone or go without needed care due to cost.” Medicaid pharmacy benefit coverage is currently split at roughly 70% managed care and 30% fee for service.
Catering to the demographic — The days of running a cookie-cutter pharmacy and being successful are waning fast. Pharmacies that can distinguish themselves are more likely to succeed. We’ve highlighted some of the ways they can do so above. One other approach that’s becoming increasingly vital is a pharmacy’s ability to adapt products, services, and marketing activities to better serve its demographic makeup. For example, one step that a pharmacy with a large Hispanic consumer population will want to consider is hiring bilingual staff to properly serve Spanish speakers. Understanding one’s target audience(s) and modifying operations to better cater to their needs can help a pharmacy focus its marketing efforts, facilitate lasting relationships, and achieve faster growth.
Electronic prior authorization (ePA) — Historically, pharmacists have spent substantial time securing prior authorizations. As research has demonstrated, implementing ePA can have a significant, positive impact on the process, including reducing the time between a request for prior authorization and a decision, decreasing the time to a patient receiving care, and reducing the time and resources allocated to prior authorizations. States like California have mandated the use of ePA and electronic medical records, with other states following suit. While such electronic tools can enable pharmacists more quickly and easily complete prescribing and care planning, there are some downsides to this migration, which is noted below.
Retail Pharmacy Challenges
These are some of the headwinds for the retail business.
Competition — Competition is projected to intensify in the coming years, particularly from big-box retailers and mail-order and online pharmacies. The pandemic motivated many consumers to use mail-order and online pharmacies to reduce their risk of exposure to COVID-19, some of whom will continue to use these services rather than go back to their local pharmacy. Payors have also steered consumers toward mail ordering, such as by covering a 90-day supply of medications delivered to the home versus only a 30-day supply available at a brick-and-mortar pharmacy. Finally, Internet pharmacies are aggressively targeting cash-paying customers by offering medications at a reduced cost.
Pharmacist bandwidth — The time that pharmacists can spend directly supporting patients and delivering care is being squeezed by requirements, such as securing prior authorizations and performing care planning. Even with electronic tools, these processes still require a fair amount of time, as does implementing and learning how to use such solutions properly and effectively. The more time spent performing back-end tasks, the less time that’s available for pharmacists to help and build relationships with customers.
Retail sales — Pharmacies that rely on in-person sales to remain viable have had it rough over the past few years. Retail sales were already declining before the pandemic. Then, as Fortune recently reported, “Most pharmacies … saw a decline in prescriptions last year as customers hesitated to visit their doctors for anything but emergencies. That drop in business also meant fewer sales of over-the-counter medicines and ancillary items sold by the stores.” While there are ways to get foot traffic into pharmacies, some of which are highlighted above, growing retail sales will continue to be an uphill battle, especially as competition grows and shopping increasingly moves online.
Amazon — In a November 2020 SalientValue column discussing pharmacy trends from 2020, Amazon was highlighted several times, and for good reason. The company is a threat to retail pharmacies on multiple fronts. Initially, the emergence of Amazon.com gave consumers less of a reason to do in-person shopping for general merchandise. Then the company got into the prescription game with its 2018 acquisition of PillPack and the 2020 launching of Amazon Pharmacy and an Amazon Prime prescription discount benefit. And then, just a few months ago, Business Insider reported that Amazon was looking to create physical pharmacies. Whether that comes to fruition — and what it would look like — remains to be seen, but one thing is clear: Amazon will continue to be a thorn in the side and strain on the bottom line of retail pharmacies.
Margins — Retail pharmacies continue to face downward pressures on their profitability. Reimbursement is tightening and costs are on the rise for everything from salaries to rent to more cumbersome accreditation and licensing requirements. In addition, pharmacies are finding themselves forced to invest in new technology (e.g., ePA) and products that can help keep them compliant and competitive. All of this contributes to continuously shrinking margins that threaten long-term viability.
How Much Will Retail Pharmacy Buyers Pay (Market Multiples)?
Now that we have touched on some of the most significant tailwinds and headwinds facing the retail pharmacy industry, let’s take a moment to acknowledge another trend that’s also going to cause significant disruption going forward: increasing mergers and acquisitions (M&A). We have witnessed a notable uptick in transactions in recent months, buoyed by the gradual winding down of the pandemic here in the United States. If you’re like one of the many retail pharmacy owners contemplating a sale, read on to gain a better understanding of the value of your pharmacy.
Buyers of companies, including retail pharmacies, go through a risk/reward analysis when determining an offering purchase price. The offering price is typically based on a multiple of normalized or adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA).
Adjustments to EBITDA include nonrecurring expenses, such as one-time legal fees; discretionary expenses, such as charitable contributions; and owner-related personal expenses, such as excess owners’ salaries and auto lease expenses.
Market multiples refer to the estimated purchase price, or enterprise value, related to annual revenue, annual scripts, adjusted EBITDA, and other performance measures. The current range of market multiples of adjusted EBITDA for retail pharmacies is 2.5x to 5.5x. A particular pharmacy falls within the range based on quantitative factors, such as historical and projected financial performance, earnings trends, annual number of scripts, annual inventory turnover, and qualitative factors, such as insurance contracts, payer mix, brand versus generic drugs, new prescriptions versus refills, location(s), competition, and number of full-time pharmacists. Moreover, size matters, as larger revenue pharmacies typically attract more buyers than smaller pharmacies.
The following are estimated market multiples for retail pharmacies by revenue, assuming positive quantitative and qualitative factors:
· $1 million to $5 million in annual revenue (2.50x to 3.50x adjusted EBITDA)
· $5 million to $10 million in annual revenue (3.25x to 4.25x adjusted EBITDA)
· $10 million to $25 million in annual revenue (4.00x to 5.00x adjusted EBITDA)
· $25 million-plus (4.50x to 5.50x adjusted EBITDA)
For example, a retail pharmacy with $5.5 million in annual revenue and $550,000 in adjusted EBITDA (10% adjusted EBITDA margin) would have a market value in the range of $1.8 million to $2.3 million. Additionally, many buyers add the value of inventory to the values determined by the market multiples above.
Note that buyers are keenly attracted to retail pharmacies with increasing annual revenue, greater than 5.0% profit margins, greater than 10.0% adjusted EBITDA margins, and greater than 10 times inventory turnover.
There are outlier market multiples in unique M&A transactions where optimal buyer/seller synergies push valuations above the norm. Moreover, market multiples change over time depending on the overall economy, regulatory and reimbursement modifications, and industry trends.
While using market multiples is an excellent way to estimate a company’s value, it is most often accompanied by using a discounted cash flow approach. The discounted cash flow approach estimates a company’s value by calculating the future cash flows expected from the company and putting the future cash flows into today’s dollars. With that said, market multiples provides a useful shortcut for estimating the value of a company.
Contributing Advisors
