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Cloud of Sept. 11 still darkens lucrative NYC market: Manhattan-based Duane Reade continues to dominate its home turf, as it has mastered the science of nailing prime locations and making the most of small, pricey real estate space

Antoinette Alexander

While New York City has yet to make a full recovery from the terrorist attacks on the World Trade Center nearly four years ago, the city undoubtedly has made significant headway as the unemployment rate declines and the retail vacancy rate improves, paving the way for solid growth of Manhattan retail. But it won't be, easy.

As the words Frank Sinatra sang suggest--"If I can make it there, I'll make it anywhere"--the dense and extremely diverse Manhattan market is challenging for the aspiring Broadway actor and the drug retailer alike.

The aftermath of Sept. 11 has been especially difficult, as local companies such as Duane Reade, the largest drug chain in metro New York with 249 stores, can attest.

According to the Lower Manhattan Development Corp., a joint state-city corporation created following Sept. 11 to help rebuild lower Manhattan, it is estimated that New York City lost 146,000 jobs as a direct result of the events of Sept. 11. LMDC puts the city's total economic loss resulting from Sept. 11 at between $83 billion and $95 billion and attributes most of that to lower Manhattan. However, thanks in part to federal government grants to large and small businesses to help keep businesses downtown and attract new businesses to the devastated area, the city's economy appears to be on the upswing.

Downtown, however, "is far from its pre-Sept. 11 prosperity, with revitalization of the area expected to last for at least 10 years," stated real estate firm Grubb & Ellis in a recent research report. "Improving transportation access is crucial to the revitalization plan."

In general, the city's economy is expected to continue its slow upward climb through 2005. According to real estate brokerage firm Marcus & Millichap, New York City should see 69,000 new jobs in 2005. Employment rose 1 percent in 2004, and a 1.7 percent hike is forecast for 2005.

Marcus & Millichap noted that Manhattan retail properties are in line to post a 40-basis-point reduction in vacancy this year to 5.9 percent, as retail sales in the region are forecast to hit $98 billion this year, up 2.7 percent from the year-ago period.

"When residential real estate is strong, so is the retail market. The veracity of this adage will be confirmed in the months ahead, as Manhattan's surging residential market will stimulate retailer space demand," stated Marcus & Millichap in a recent Retail Research Report.

While the economic upswing is, of course, good news, for retailers looking to crack the already challenging Manhattan market, it means battling a decline in property vacancies and an increase in lease rates.

There are five major drug chains within Manhattan's borders--Duane Reade, Rite Aid, CVS, Brooks-Eckerd and Walgreens--but the competition is bound to get tougher as big-box retailers including Wal-Mart loom and newcomers such as Boulder, Colo.-based Pharmaca Integrative Pharmacy eye the market. These developments are not likely to be good for Duane Reade.

Manhattan-based Duane Reade continues to dominate its home turf--at least for now--as it has mastered the science of nailing prime locations and making the most of small, pricey real estate space. However, the company, which is now private following its July 2004 acquisition by Oak Hill Capital Partners, has been experiencing a decline in its operating performance since the fourth quarter of 2001. Citing the chain's leveraged capital structure, thin cash flow protection measures and narrow geographic focus, Standard & Poor's recently lowered the chain's corporate credit rating to CCC+ (i.e., vulnerable) from B- and stated that the outlook is negative.

"The downgrade is based on the company's weaker-than-expected operating trends in the first quarter of 2005 and our heightened concern about management's ability to turn around a deteriorating performance," stated Standard & Poor's credit analyst Diane Shand.

The downgrade came after the chain posted a loss for the first quarter ended March 26 of $11.7 million, including expenses, compared with a gain in the year-ago period of $1.8 million.

Duane Reade, which plans to open eight to 10 new locations and close about 10 to 12 units in 2005, also is feeling heat from industry observers regarding its own potential self-cannibalization in Manhattan, resulting in a dampening of comp-store growth.

The chain has been looking to more outer-borough locations, given its mature Manhattan store base. However, the difficulty is that outer-borough stores take longer to mature and face greater competition from rivals such as Brooks-Eckerd.

Since Brooks Pharmacy closed on its acquisition of 1,539 Eckerd stores on July 31, 2004, the Warwick, R.I.-based chain has been working at a blistering pace to reverse Eckerd's lackluster performance, and the efforts are paying off. According to Chain Store Guides data, Brooks' management boosted front-end market share at the former Eckerd stores in file New York area from 9.6 percent to 10.8 percent in the remaining four months of 2004.

CVS and Rite Aid have pulled back their expansion programs in New York City, and Walgreens also has faced sluggish growth in the city, with just three stores currently open. Among the culprits holding down growth in the Big Apple: expensive real estate, high labor and operating costs and challenging logistics.

While still facing fierce resistance, big-box retailers--perhaps taking their cue from Home Depot's two new scaled-down, urbanized stores in Manhattan--eventually could spice up the mix if they can overcome opposition from local authorities and neighborhood groups.

Recently, a planned 203,000square-foot B.J.'s Warehouse Club in the Bronx, just north of Manhattan, was scuttled, noted Marcus & Millichap, and Wal-Mart backed away from plans to build a store in Queens, which is predominantly a residential borough and host to New York's JFK and LaGuardia airports.

Meanwhile, Acadia Realty Trust is planning for the Bronx a $60 million development on a site where a Sears now stands. The Sears lease expires in 2007, and Acadia is hoping to redevelop the site to attract national retailers, such as Target and Kohl's, according to Marcus & Millichap.

One to beat

Duane Reade is the market leader in Manhattan with 249 stores in metro New York, and--despite the drug chain's financial woes--that is not likely to change in the near future as big players like Walgreens and CVS have shied away from the Big Apple's limited and expensive real estate, high operating costs and challenging logistics.

In 2005, Duane Reade expects to open eight to 10 new stores and shutter 10 to 12 units.

In an effort to bolster weak front-end sales, Duane Reade has implemented such front-end initiatives as ATM-like movie vending machines in about 24 stores, a Chock full o'Nuts coffee kiosk that could be expanded to as many as 100 stores and European-style skin care centers in four high-traffic areas, including one within a stone's throw of the high-priced cosmetics counters of Bloomingdale's.

One to watch

Brooks-Eckerd may operate only a handful of stores in Manhattan, but the Brooks management team is making impressive strides in turning around the ailing former Eckerd stores.

With the help of lower prices on thousands of items, an in-store remerchandising initiative and a new circular program, Brooks' management has bolstered front-end market share in its New York area stores from 9.6 percent to 10.8 percent between July 31, 2004--the day the acquisition officially closed--and December 2004, according to Chain Store Guides' 2004 estimates. In general, the focus has been a return to operating the Eckerd stores like drug stores again.

Much like Duane Reade, Brooks-Eckerd has introduced Manhattan to its European-style skin care centers, dubbed Derma Skincare Centers. One such location is a former Eckerd unit in trendy SoHo.

One for the books

It may not have a pharmacy department, but when it comes to health and beauty aids, Manhattan-based Ricky's Urban Groove is a tough contender with its eclectic mix of private label, mass, specialty and hard-to-find brands.

The 20-store chain, which also now operates two Miami stores and one in East Hampton, N.Y., is well known for its Halloween offering, but is working to focus on its core business: beauty. Such a move will mean greater competition for the beauty business at drug chains in New York, including Duane Reade, Rite Aid, CVS, Brooks-Eckerd and Walgreens.

As part of the effort, the company is taking a closer look at Mattese NYC, its private label makeup artist line. The company is working on a relaunch and may expand distribution for the collection into some overseas and local, noncompeting retailers.

Over the next few years, the chain is looking to expand nationwide and is eyeing major metro markets.

NEW YORK: WHO'S WINNING *

                  2004 Rx      2004 front-end     Total stores
                market share   market share (")       w/Rx

CVS                 25.0%           21.6%             416
Duane Reade         15.6            21.8              240
Rite Aid            12.9            14.2              301
Brooks-Eckerd       11.5            10.8              208
Walgreens            6.6             7.8              105

Source: Chain Store Guides 2004 Drug Industry Market Share Report
Market defined as greater New York area, including New York City,
Long Island, Westchester, Rockland, N.Y.; Bergen, Essex, Hudson,
Middlesex, Monmouth, Morris, Ocean, Passaic, Somerset, Sussex
and Union counties in N.J. (") Reflects drug stores only

NEW YORK: THE STAKES *

Population                                    18,702,285
No. of households                              6,804,695
Median disposable
  income ([dagger])                              $44,995
Total Rx sales **                               $7,268.6
Total front-end ([dagger][dagger]) sales **     $3,794.1

THE SIDES

Drug stores                                        2,468
Supermarkets                                       1,234
Mass merchants                                       269
Warehouse clubs                                       51

Source: Chain Store Guides 2004 Drug Industry
Market Share Report

* Market defined as greater New York area, including
New York City, Long Island, Westchester, Rockland,
N.Y.; Bergen, Essex, Hudson, Middlesex, Monmouth,
Morris, Ocean, Passaic, Somerset, Sussex and
Union counties in N.J. ** Sales in millions ([dagger]) Per
household ([dagger][dagger]) Reflects drug stores only

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