NEW YORK — With the economic recovery well under way, chain drug retailers can expect a year of growth in 2011, industry analysts say.

A reviving job market and rebound in household wealth have lifted consumer confidence and spending, which should translate to more business in the pharmacy and the front end for drug chains in 2011, they explain.

However, high unemployment, shopper inflation concerns, reimbursement pressure from state governments and lingering financial constraints on many consumers will rein in growth, analysts note. Also, the profit boost expected from the upcoming generic drug wave — starting with the expiration of Lipitor’s patent late this year — won’t be realized until 2012, they add.

“We’re in the midst of an economic recovery,” says analyst Joseph Agnese of Standard & Poor’s Equity Research. “Discretionary spending was challenged last year, and it should be less so this year, although the unemployment rate is still pretty high.

“Higher oil prices will pressure the lower- to middle-income consumer. But with higher oil prices, people tend to shop locally rather than driving farther to a discount store or supercenter. So that convenience factor plays to drug stores’ benefit.”

Agnese adds that consumers should also start to spend a bit more on front-end items, which are wider-margin products for drug stores.

The retail pharmacy sector likely will see a return to “more normal” growth this year, according to Sanford Bernstein & Co. analyst Helene Wolk.

“We should see accelerating growth in prescription volume in 2011 for two reasons: Economic recovery probably has some modest effect on prescription use, and last year pharmacies were facing some unique headwinds,” Wolk says, citing the drop-off in flu-related business as one example. “Overall, this year is going to be slightly better than average in pharmacy, and it will be easier in the second half.”

In its 2011 U.S. Retail Outlook report, Fitch Ratings pegs industry prescription sales growth at about 2%. “Top-line growth at drug retailers is expected to improve modestly in 2011,” the ratings firm observes.

Drug chains have perhaps been the steadiest mass retail segment over the past few years. One advantage is their health care positioning, since customers making trips to fill prescriptions may also buy other items, analysts point out.

“Prescription volume is up, and though it may not be up very much, it’s still growing,” Wolk says. “And you get great leverage in the pharmacy.

“In the height of the recession, we saw some front-end purchases shift out of chain drug stores, likely into the discount mass merchants and maybe the dollar stores. We didn’t see that happen to pharmacy.”

According to the Standard & Poor’s Composite 1500 market index, the drug retail subindustry is one of only a few core retailing sectors on the upside for 2010, the 2011 year to date and the past five years.

As of the April 1 S&P index, drug retail showed growth of 7.2% for 2010 and 2.5% for the year to date, as well as a 1.9% five-year compound annual growth rate (CAGR). Among other mass retail sectors in the index, food retail was up 16.3% in 2010 and 9.8% for the 2011 year to date, but its five-year CAGR was down 0.1%. Hypermarkets and supercenters (including warehouse clubs) have a five-year CAGR of 3.9% yet are down 1.8% for the 2011 year to date after a 5.5% gain in 2010. Similarly, general merchandise stores are down 9.2% for the 2011 year to date after rising 32.4% in 2010 and posting a 3.5% five-year CAGR.

“We are currently positive on drug retail stocks,” analyst Ed Kelly of Credit Suisse writes in his latest “Drug Store Trend Tracker.” “Industry fundamentals appear to be improving, the upcoming generics wave is a large and underappreciated catalyst, and valuations are attractive.

“We believe drug stores are particularly well-positioned to pass through inflation, given their convenient locations (compete less on price), natural flow of pharmacy traffic and low average ticket," he adds.

Flu activity has tailed off after peaking in mid-February but is still above last year’s levels, according to Kelly. “We believe the slow recovery in underlying front-end comps continued in March, reflecting an improving consumer, traffic gains from increased flu activity [year over year] and price inflation,” he said in a monthly sales analysis.

Chain drug retailers also are making headway with some key strategic initiatives. For instance, their efforts to expand consumables and grocery offerings have snared business from traditional food retailers, according to Agnese, and SKU rationalization has better positioned drug stores as a convenient outlet for staple items amid a rough economy.

“SKU rationalization also helps make shopping easier for consumers and improves the shopping experience, which can go a long way toward improving customer loyalty,” he says. “If they have a better experience in the drug store, they’re more likely to think of stopping there in the future.”

Programs to spur patient adherence to medications, help manage chronic disease and provide work-site prescription and health services add to pharmacy volume as well, Wolk says. In-store clinics, too, are catching customers’ attention as a convenient destination for flu shots and a growing array of services, such as health screenings and physicals, she adds.

“They’re finding more ways to grow revenue in the clinic,” notes Wolk. “It’s going to become a much more diverse health care model than it is today.”

And that plays well with current demographic trends, notes Agnese. “The health services available through in-store clinics are gearing drug stores for the eventuality that they’ll be looked at to meet the demand coming from aging boomers as well as more people being covered by health insurance,” he says. “They’ve done a lot to make consumers think of them as a health care alternative.”

Looking ahead, the leading drug chains will be razor-focused on boosting their financial results to augment market share, since opportunities for dramatic growth via mergers or acquisitions remain scarce, according to analysts.

“Further large-scale acquisition opportunities are limited as CVS Caremark, Walgreens and Rite Aid — the three largest chain [drug] retailers — account for approximately 38% of industry revenue (or 43% including CVS’ pharmacy benefit management business),” Fitch observed in its 2011 U.S. Retail Outlook. “Therefore, share gains will depend on generating above-average organic growth, store closings or share losses by weaker independents and regional chains, small market fill-in acquisitions, and prescription file buys.”

Sanford Bernstein’s Wolk commented, “Expect CVS and Walgreens to be actively looking at some of those small chains.”

Though the large chains are getting larger, a challenge from outside the traditional drug channel may be on the horizon, according to S&P’s Agnese.

“An intermediate to longer-term threat would be Walmart with its smaller-format stores,” he says. “If those stores have pharmacies, that could be a lot of trouble for drug stores, especially because they’d have to have a tremendous number of those stores. So they could easily be thought of as an alternative to drug store chains.”

*To read the full Industry Outlook report, plus economic analysis, drug chain profiles, interviews with chain drug retailing leaders and industry trend articles, see the State of the Industry report in the April 25, 2011, print issue of Chain Drug Review.