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Rite Aid Turns a Profit: Why I'm Not Impressed

On Thursday morning, Rite Aid (NYSE: RAD  ) posted a fourth-quarter EPS of $0.13, which beat the average analyst estimate for a slight loss. This quarterly profit -- the second in a row for Rite Aid -- allowed the company to post its first full year of profitability since 2007. This surprisingly strong performance caused Rite Aid shares to soar nearly 30% over the course of Thursday and Friday, to highs not seen for almost five years.

RAD Chart

Rite Aid 5 Year Price Chart, data by YCharts.

Nevertheless, Rite Aid's relatively strong fiscal year 2013 results were driven by a number of one-time or short-term benefits. These items helped mask the company's fundamental competitive disadvantages vis-a-vis larger rivals Walgreen (NASDAQ: WBA  ) and CVS Caremark (NYSE: CVS  ) . While Rite Aid could generate impressive stock returns in a best-case scenario, the company's poor competitive positioning creates substantial long-term risk for shareholders. Therefore, I still think investors would be wise to avoid the stock.

Strong results, modest outlook
Rite Aid's profit was driven by three major one-time or short-term impacts. First, the company gained a number of new customers from Walgreen's dispute with pharmacy benefits manager Express Scripts (NASDAQ: ESRX  ) . Walgreen's stores rejoined the Express Scripts network as of Sept. 15, and customers are beginning to trickle back, but Rite Aid still saw a significant benefit from the dispute in fiscal year 2013. On Rite Aid's Thursday morning conference call, executives estimated the full-year benefit at $70 million -- more than half of the company's fiscal year 2013 profit.

Second, Rite Aid -- as well as other pharmacy chains -- gained additional sales this quarter from a particularly bad flu season. For example, in January, Rite Aid reported a 5% increase in prescription count, with more than two-thirds of the increase attributable to flu shots and flu-related prescriptions. Last, pharmacy chains achieved higher profit margins this year due to the introduction of a number of new generic drugs, which are more profitable than brand-name drugs.  Over time, reductions in insurance reimbursement rates will negate this margin increase.

Looking forward, Rite Aid expects same-store sales, adjusted EBITDA, and net income to all be roughly flat next year. Management called attention to the loss of some Express Scripts customers who will return to Walgreen's, fewer generic introductions, and reductions in reimbursement rates as major headwinds for fiscal year 2014. If Rite Aid executives are being overly conservative with their guidance, then the stock could continue to rise. However, based on Rite Aid's fairly uninspiring March sales results, I think the guidance for flat sales and earnings next year is very appropriate.

Encroaching competitors
Longer-term, I think Rite Aid will have trouble remaining profitable in the face of strong competition from its two larger rivals. Rite Aid has benefited from trends such as the growth of generics and the aging of the U.S. population, which are helping the whole industry. For Rite Aid, improving industry conditions have allowed the company to reduce its leverage while remodeling a few hundred stores each year. By contrast, Walgreen and CVS have more resources at their disposal, and so strong profitability has encouraged expansion. In their most recent fiscal years, CVS added 131 stores, and Walgreen added 175 stores.

Convenience is paramount in the drugstore business, and as Walgreen and CVS add locations -- thereby moving closer to customers -- they will gain market share. Expansion will also increase economies of scale for both chains. Rite Aid does not have the capital resources to expand, and has actually been reducing its store count. In the short term, closing underperforming stores should boost Rite Aid's profitability, but in the longer term, this will increase the competitive advantages of Walgreen and CVS.

Buyer beware
Rite Aid's high leverage gives the stock substantial upside if management is able to enact a sustainable turnaround. However, I am not optimistic about Rite Aid's chances in an industry where its two main competitors are significantly larger and expanding, while Rite Aid is slowly shrinking. As Walgreen and CVS move closer to customers through store expansion, Rite Aid will struggle to maintain its market share. As a result, the company's return to profitability could prove short-lived.

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Read/Post Comments (4) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 15, 2013, at 12:41 PM, masterwallstreet wrote:

    In my opinion only I think you're wrong again. You are telling people to avoid this before earnings come out and instead of admitting you were wrong, you are insisting that this is a bad investment. Other opportunities are available elsewhere. Other analysts are upgrading this to a strong buy and a buy we are getting more positive news everyday. My opinion is that this stock could double or triple before Walgreens and CVS. That means I could make a lot more money if I am right investing in Rite Aid than Walgreens or CVS.

  • Report this Comment On April 15, 2013, at 1:00 PM, jackm12 wrote:

    This is the exact same sh*t that made me sell RAD at 1.30 becuase of these fools. The stock never looked back and went to watch out for these guys.......I think they never bought it at lower levels and now want to get in.

    RAD is very powerful, sooner or later it would go to moon by itself or get bought out by WAG or someone else.

  • Report this Comment On April 15, 2013, at 1:04 PM, freefood89 wrote:

    I feel that this article has errors... Rite Aid lost ground on Sales. Their positive earnings was almost purely from dumping unprofitable stores and making margins positive. Consequently there is a concern whether sales growth is possible after all the cost cutting, as this means RAD will actually have to compete with CVS and Walgreens.

    However, RAD's smart management action was able to make the stock investment-worthy again, and maybe even credit worthy with their declining debt load, which was their primary concern (bankrupcy!)

  • Report this Comment On April 29, 2013, at 9:35 PM, WelderTennessee wrote:

    A year ago, when the stock was trading under $1.00, you said it was a bad investment. Two months ago, you said it was bad investment. It spiked up, you said it was good. It dropped and came back up, and now it's bad again.

    Seems to me that you like a stock at all the wrong times. Personally, I was buying this stock back when it was about $.50 a share. I bought lows and sold highs. I still think it's a good deal.

    Focusing on about a month long increase in sales due to the ExpressScripts drama isn't looking at the big picture. This is the #3 drug store chain in the country. They are firmly established, nation wide. I could see them either improving market share, or getting bought out by CVS or Walgreens. Currently, both are fighting for the #1 spot, and purchasing RiteAid would put them very firmly in the lead, drastically increasing buying power, as well as lowering costs through improved logistics.

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