Everyone knows the first rule of real estate success is location, location, location.

That’s why office buildings are built in big cities with lots of white-collar job opportunities… apartment complexes are built close to large populations… and retailers prefer sites along high-traffic corridors. When it comes to commercial real estate (“CRE”), you have to be where your ideal customers are.

Otherwise, your sales will suffer. It’s Logic 101.

However, location isn’t the only factor that can make or break a company. It’s not quite as simple as “build it and they will come.”

For one thing, you have to build something people want or need. Then you have to present it in such a way that draws them in and keeps them coming back.

And finally, you need to protect your business against the competition. As I’ve written about before, successful companies must have economic “moats” that allow them to reap sustainable profits.

That’s why I would spend so much time analyzing prospective tenants back in my CRE development days. If I was going to become someone’s landlord, I needed to ensure it had a real competitive advantage – some aspect that would keep it profitable enough to keep paying me for years on end.

I had a lot more winners than losers operating under that commitment to quality. There are no crystal balls to help you achieve a perfect track record, at least so far as I’ve seen. So I did have a few contracts that caused me grief.

But for the most part, I made pretty decent money from the companies I leased to.

The problem is, my investigative job wasn’t really done once I’d approved a lease.

Just because a business is protected one day doesn’t mean its moat might not dry up tomorrow. You have to stay vigilant if you’re going to stay profitable.

Two prominent companies I built for back in the day are sad proof of how true that is.

The Making of a Drugstore Dinosaur

I began building drugstores in the 1990s, which was the decade of expansion in the pharmacy sector.

My first such client was Eckerd Drug, which was eventually bought out by Rite Aid. Then I began building stores for Walgreens Boots Alliance (WBA) and CVS (CVS), both A-rated companies at the time.

Those contracts paid off for quite a while. In fact, from 2000 to 2010 – even after the Great Recession hit – the pharmacy industry grew by $120.8 billion. Though that was admittedly distributed between drugstore chains, grocery stores, and mail-order pharmacies, it was still significant growth.

But then the Internet really began taking over, leeching money slowly but surely from its drugstore predecessors. The result, according to a study by Qato and other researchers, found that 29.4% of the 88,930 retail pharmacies opened in the U.S. between 2010 and 2020 had shuttered by 2021.

That doesn’t completely surprise me.

As a former developer, I know that the typical Walgreens or CVS is around 13,000 to 15,000 square feet. I would pay as much as $1.5 million for around 1.5 acres, then sign the tenant to a 20-year lease at above-market rent.

These drugstores never objected… which I never quite understood. After all, how could they afford to pay top dollar when they were competing with grocery and dollar stores – to say nothing about the Internet – on greeting cards, shampoo, candy, and toilet paper?

That’s why I just wasn’t shocked when Walgreens announced last month that Sycamore Partners would buy it in a $23.7 billion all-cash deal. And that’s after it announced it would close 1,200 stores through 2027.

It’s suffering too much not to sell.

Admittedly, CVS maintains an investment-grade rating of BBB and should grow 8% in 2025, 16% in 2026, and 15% in 2027. So clearly a brick-and-mortar pharmacy can survive.

It’s just not nearly as easy as it used to be.

A Parts Chain in Neutral

Before Eckard’s, my very first development customer was Advance Auto Parts (AAP). Back then, it was a privately held, family-owned chain based in Roanoke, Virginia.

At the time, Advance Auto had less than 100 stores. Today, it’s one of the most dominant auto-parts chains in the country thanks, in part, to a string of acquisitions:

• Western Auto in 1998

• Carport Auto Parts and Discount Auto Parts in 2001

• Trak Auto in 2002

• BWP Distributors in 2012

• General Parts International in 2013

• DieHard (from Sears) in 2019

Essentially, no smaller-scale chain could keep up.

Yet there were two other competitors just as determined to dominate, one of them being AutoZone (AZO). Founded in 1979, it now runs 7,140 stores across the U.S., Mexico, Puerto Rico, Brazil, and the U.S. Virgin Islands.

Missouri-based O’Reilly Automotive (ORLY), meanwhile, was founded in 1957 and operates more than 6,000 stores in 48 states, Puerto Rico and Mexico.

As a result of that kind of competition, plus the all-impactful Internet, Advance Auto has seen profits erode. Earnings tanked from $13.04 per share in 2020 to just $0.50 in 2023, prompting the company to halve its dividend.

Within the last two years, S&P even downgraded it from BBB- to BB-, stripping away its investment-grade status.

It has since installed Shane O’Kelly as CEO, who hopes to “get the gears moving” by reducing cost and improving earnings. His plan includes closing around 500 stores, 200 independent locations, and four distribution centers by mid-2025.

It does, admittedly, plan to open 30 new locations across the U.S. with the long-term goal of opening at least 100 by 2027. But this is while AutoZone and O’Reilly continue to gain market share with expansionary plans of their own.

 

Considering my history with both Advance Auto and Walgreens, I have to admit to feeling slightly sad about their falls. They used to be excellent tenants and investments.

Yet no amount of nostalgia can hide how their respective moats have dried up as much as they have.

Never forget that you’re investing to profit. So when an asset shows serious and lasting signs of failing in that regard, it’s time to walk away and find more healthy places to put your money.

Stay tuned, because next week I will be writing about two of my former tenants that have not only survived but thrived due to their wide-moat attributes.

Regards,

Brad Thomas
Editor, Wide Moat Daily

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Have you seen other examples of a company’s moat drying up? Write us at feedback@widemoatresearch.com.