What Does GNC's Renewed Agreement With Rite Aid Imply About Its Future?
Have you ever heard in business that it's not what you know, it's who you know that counts? The saying implies that relationships are not just important in business, but imperative if you want any hope of success. One company that realized this early on was GNC Holdings , a provider of nutritional supplements based out of Pittsburgh.
Throughout the past several years, the company has struck deals with Rite Aid , PetSmart, and Sam's Club, a segment of Wal-Mart. The company's most recent agreement involved it renewing its relationship with Rite Aid through 2019 and adding GNC locations to at least 300 additional Rite Aid stores. Using these relationships, GNC strives to increase its market share, but as I chronicled in an earlier article, it has to accept some downsides. It is also provided some very attractive benefits.
Revenue is impaired
Perhaps the most interesting of GNC relationship's is with Rite Aid. According to an agreement between these two companies, GNC has been able to set up a store-within-a-store model inside of various Rite Aid locations. Such a decision between two companies to join forces in this way may appear to be odd, but the model has worked out so well that other retailers like J.C. Penney have adopted it.
In an effort to grow its business, J.C. Penney began implementing a store-within-a-store setup as early as 2007. However, the company began experiencing financial strain after its former CEO, Mike Ullman, retired and Ron Johnson, a former executive at Apple, took his place. Johnson, who believed that coupons were bad for customers and that instead J.C. Penney should abolish them and adopt a policy of everyday low prices, was also responsible for pushing the store-within-a-store initiative with Martha Stewart Living as its flagship test subject.
After seeing revenue decline significantly and a net gain transform into a net loss, Johnson was ousted and Ullman was brought back in with the goal of turning the business around. Recognizing the appeal of the store-within-a-store model, Ullman elected to continue and expand the concept by bringing in big names like Disney. Since then, the store-within-a-store design has been a cornerstone for J.C. Penney's attempted turnaround.
By the end of GNC's 2012 fiscal year, it had this kind of setup inside 2,181 Rite Aid locations. To put this in perspective, 26.8% of GNC's locations were located inside of Rite Aid stores, far from being insignificant. Despite this, total revenue from these locations only accounted for 2.5% (or $60.75 million) of the company's consolidated revenue for the year.
On a per-store basis, this implies revenue of $27,854. In contrast, revenue for the stand-alone retail and franchise locations averaged $367,538 per year, which indicates there is a lot more value to be had by foregoing said partnerships.
Unlike the company's agreement with Rite Aid, its relationships with Sam's Club and PetSmart don't involve a store-within-a-store design. Because of this, it's impossible to break down revenue the company receives from each entity, but we can conclude that it generated combined revenue of $176.1 million from them in 2012 and $158.8 million in 2011.
This means that while revenue only grew 1.1% for its Rite Aid locations between 2011 and 2012, it rose 10.9% in the company's other business alliances. Growth like this is nothing to scoff at, but it fell short of the 17.3% growth the company experienced on a consolidated basis.
But revenue isn't all that matters!
Looking only at revenue, we might say that GNC would be better off not having its stores located within Rite Aid and possibly not even through its connections with Wal-Mart and PetSmart. This would be especially true if the company's margins from these relationships were smaller than its retail and franchise segments. If this were the case, management would be wise to abandon these endeavors and instead refocus their efforts on adding to their retail or franchise locations.
Interestingly, this isn't the case. Although growth is lower than it is in the company's retail and franchise operations, margins are considerably higher. In 2012, the operating margin for this segment came out to an impressive 40.3%. This marks an annual increase from the 37.7% operating margin earned in 2010 and has been attributed to higher wholesale margins (aka economies of scale) and greater proprietary shipments.
These results are far higher than the 19.4% operating margin of the company's retail segment and slightly higher than its franchise segment, which earned 33.4% last year. Admittedly, these operating segments have both experienced improvements over the past three years, but still have some ways to go before matching the company's manufacturing/wholesale segment.
Based on the data provided by GNC, the company is trying to take a multifaceted approach to improving its business. By focusing on its retail or franchise operations, management could ensure greater prospects but would be forgoing some considerable margins. For this reason alone, the company is smart in focusing most of its time and energy growing its other segments in the hopes that as its business becomes larger, management's ability to engage in these lucrative contracts will grow as well.
Ideally, management and shareholders alike are probably hoping to move more toward such licensing agreements down the road, but unless the company wants to cut revenue significantly, this isn't likely anytime soon. Rather, it would be reasonable to see licensing agreements with third parties grow as a percentage of revenue over time, especially as franchise opportunities eventually slow their growth in light of more market saturation.
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The article What Does GNC's Renewed Agreement With Rite Aid Imply About Its Future? originally appeared on Fool.com.Daniel Jones has no position in any stocks mentioned. The Motley Fool recommends PetSmart. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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