Why Rexall’s American owner wants to sell the pharmacy chain — and might unload it at a loss

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Pharmaceutical supply giant McKesson Corp. MCK-N had a grand vision for Canadian expansion about 15 years ago: Scoop up a slew of pharmacies, integrate them with its global distribution business, and print money.

The buying spree started in 2008 with 270 independently owned pharmacies operating under the Proxim and ProxiMeds brands in Quebec, then accelerated in 2012 with pharmacies owned by the Katz Group, whose banners included IDA and Guardian Drugs.

McKesson landed its big fish in 2016, buying Rexall from the Katz family for $2.9-billion, adding 470 drug stores and a few other assets to its network in one shot.

Yet what was supposed to be the crown jewel has only caused headaches for McKesson, and the company is now trying to sell Rexall, The Globe and Mail reported last week. To get a deal done, McKesson may have to unload the business at a loss.

“They overpaid for the Rexall chain,” said Jim Danahy, who has been involved in the pharmacy industry as both an owner and an adviser for 30 years and is the chief executive of retail consultancy CustomerLAB.

Historically, pharmacies were very profitable businesses. “There used to be a time where you could make money in spite of yourself,” said Mike Jaczko, a pharmacist by training who went on to be a retail pharmacy executive, including at the Katz Group, and is now a portfolio manager at KJ Harrison Investors who helps pharmacists sell their businesses.

But over a few decades, the industry dynamics have changed, Mr. Jaczko explained. For one, there’s more competition, and pharmacies are now embedded with so many retailers, including Walmart and Costco. Land values have also soared, which has increased rents for operators that don’t own their real estate.

Canadian pharmacy owners were also dealt a trifecta of operating challenges right after the Rexall deal closed: New rules slashed prices on generic drugs, which are medicines that have lost their patents and are increasingly used to filled prescriptions in Canada; there were cutbacks in government subsidies for pharmacists’ services (such as medication counselling); and higher minimum-wage laws in Alberta and Ontario increased pharmacies’ costs.

To offset the pain, pharmacy owners needed to make more money off of their front-of-store operations, such as the sales of food, cosmetics and first-aid products. Yet Texas-based McKesson specializes in pharmaceutical distribution, and that put Rexall in a tough position. “They’re not a retailer,” said Mr. Danahy, the consultant.

Rexall also isn’t integrated with a retail partner. Shoppers Drug Mart is owned by Loblaw Cos. Ltd. L-T, for instance, and Jean Coutu is owned by Metro Inc. MRU-T These grocers have loads of customer data that can inform product decisions, and they can cross-sell some of their brand-name items, particularly food, in their drug stores.

Because of all the challenges, Rexall closed almost 10 per cent of its stores in 2018 and took a writedown.

The operational challenges keep piling up. Profit margins are getting squeezed by cost inflation, and the Canadian consumer has become more cost-conscious. Pharmacies used to make good money by charging elevated prices for everyday items, such as toilet paper, that customers would buy up out of convenience while they waited for their prescriptions to be filled. But shoppers aren’t so willing to spend that kind of money anymore, especially when rivals such as Dollarama and Amazon are often cheaper and either down the street or deliver to their door.

At the same time, the dispensing fees that pharmacies collect when filling a prescription have not risen in roughly a decade, depending on the province. “That fee stays the same, and we’re expected to do more, because of drug shortages or health care needs,” Chris Chiew, vice-president of pharmacy and health care and merchandising services with Vancouver-based London Drugs, said of the industry. For the pharmacy counters within these chains, “it makes it very difficult to maintain profitability.”

Rexall, for its part, has tried to evolve. The chain launched a storefront makeover shortly before the McKesson deal, to give it more modern look with a sea-foam green logo; it has partnered with frozen-fare specialist M&M Food Market to put M&M products into freezers, to compete with more food offerings at Shoppers; and it launched its own loyalty program, called Be Well, in 2020, among other initiatives.

Yet Rexall is still often thought of as a lesser Shoppers, especially when it comes to beauty products, because it doesn’t offer the same breadth of brands, and its store locations often are not seen as prime real estate.

By no means is the business destitute, however. Private equity firms are widely considered as potential buyers, and a number of them specialize in retail turnarounds. The matter may simply come down to price, and what McKesson is willing to accept to get the business off its hands.

With a report from Chris Hannay