Rite Aid Seems to Be Running Out of Steam

In a series of articles over the past two months, I have argued that the apparent turnaround occurring at Rite Aid (NYSE: RAD  ) over the past year or so has probably been a fluke, and that the company may be about to head downhill again. If you missed the earlier articles, the main argument is simple: In 2012, Rite Aid benefited from several one-time items that boosted profits. The two biggest factors helping Rite Aid were: 1) a dispute between Walgreen (NYSE: WAG  ) and pharmacy benefits manager Express Scripts (NASDAQ: ESRX  ) , and 2) a wave of generic-drug introductions, which improved pharmacy gross margin.

Walgreen and Express Scripts eventually came to a compromise, and since September many of the customers who had switched to Rite Aid or CVS Caremark (NYSE: CVS  ) last year have been returning to Walgreen's pharmacies. Rite Aid's management estimated the benefit of this dispute at $70 million last year, representing more than half of the company's total profit.

Furthermore, 2013 will feature a much slower pace of generic-drug introductions, while insurers continue cutting their reimbursement rates. These two factors could potentially reverse Rite Aid's pharmacy gross margin gains.  With some of last year's unusual tailwinds thus likely to reverse in fiscal year 2014, one might expect shareholders to be cautious about Rite Aid's prospects.  Instead, shares have more than doubled in the last six months, reaching a new five-year high:

RAD Chart

Rite Aid 5-Year Price Chart, data by YCharts.

Recent sales data appear to confirm a slowdown in sales at Rite Aid, which will ultimately pressure the bottom line.  Accordingly, I believe that Rite Aid shares have become overvalued during their recent run.

Sales data continues to disappoint
Last week, Rite Aid reported disappointing sales data for April. This bolsters the case that the company's surprise profit in fiscal year 2013 did not reflect a sustained improvement in the business. Same-store sales decreased 4% last month, with front-end sales down 3.5% -- partially due to the shift of Easter to March this year -- and pharmacy same-store sales down 4.2%. Prescription count was down 0.2% year over year, confirming that some customers are taking their business back to Walgreen. In fact, Walgreen experienced a 9.7% increase in prescription count last month, or 6.3% accounting for a calendar-day shift compared to 2012. The divergence in pharmacy results between Rite Aid and Walgreen is very significant.

For the combined March-April period, Rite Aid's same-store sales were down 3% due to the introduction of new generic drugs. Front-end same-store sales increased 0.1%, and prescription count also increased 0.1%. In other words, if we adjust for the timing of Easter and the effect of generic introductions, Rite Aid's comparable-store sales have not turned negative yet. That said, sales gains have slowed to a crawl, and may not be sufficient to cover normal inflation in operating expenses.

A look at Rite Aid's monthly sales data for 2012 and 2013 (year to date) shows a clear downward trend. To be fair, some of the deceleration in late 2012 was caused by a higher rate of new generic introductions. However, this effect has tapered off in the past several months, while the downtrend continues:

Rite Aid same-store sales

Month

Change in Same-Store Sales

January 2012

2.2%

February 2012

3.1%

March 2012

3.6%

April 2012

2.9%

May 2012

1.1%

June 2012

(1%)

July 2012

0.5%

August 2012

0.4%

September 2012

(0.7%)

October 2012

(1.1%)

November 2012

(3%)

December 2012

(2.2%)

January 2013

0.3%

February 2013

(3.6%)

March 2013

(2%)

April 2013

(4%)

Source: Rite Aid monthly sales releases.

Alternatively, since a picture is worth a thousand words, consider the following chart of same-store sales.  If this picture doesn't make you second-guess Rite Aid's soaring share price, I don't know what will!

Data drawn from Rite Aid monthly press releases (as shown in table above).

Foolish bottom line
Rite Aid is trapped between a rock and a hard place: namely, CVS and Walgreen. While Rite Aid is a large drugstore chain, CVS and Walgreen are both bigger and growing, while Rite Aid continues to shrink. CVS and Walgreen will continue to build on their competitive advantages, such as convenient locations, large purchasing scale, and strong balance sheets, to support further investments.

I think Rite Aid will have trouble keeping up with these two behemoths in the long run, while the company's $6 billion debt load makes it an unappealing acquisition target. Furthermore, the stock is not particularly cheap; it trades at more than 20 times earnings.  That's why I'm bearish on Rite Aid. Accordingly, I have entered a long-term underperform rating for the stock on my CAPS page.  Let me know what you think in the comments box below.

Changes on the health care horizon
Obamacare will undoubtedly have far-reaching effects. The Motley Fool's new free report "Everything You Need to Know About Obamacare" lets you know how your health insurance, your taxes, and your portfolio will be affected. Click here to read more. 


Read/Post Comments (8) | Recommend This Article (7)

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 May 06, 2013, at 11:48 AM, masterwallstreet wrote:

    I kind of disagree with your article. Recently Walgreens and CVS hit 52 week highs. Walgreens high was $50.35 and now it is $47.96. Rite Aid stock hit a 52 week high of $2.68. Now it is $2.60. If you compare both of these I believe that Walgreens is dropping faster than Rite Aid is. Rite Aid has a possibility of doubling or tripling. They both carry the same amount of debt. Walgreens pays dividends which is a liability to the company, not an asset. If you had 10,000 shares and bought it at a 52 week high how much money would you have lost if you compare both of them. At 10,000 shares you would have lost $800.00 of Rite Aid. At 10,000 shares you would have lost over $24,000 of Walgreens. I believe that if you compare them Rite Aid is the better bet and investment opportunity than Walgreens. Walgreens is overpriced. Rite Aid is underpriced. As an investor, I would rather own Rite Aid than Walgreens right now at the present time and conditions. This is my opinion only.

  • Report this Comment On May 06, 2013, at 11:51 AM, bestwaytoriches wrote:

    Master Wall Street said it all. RAD will out preform

  • Report this Comment On May 06, 2013, at 12:46 PM, EvanBuck wrote:

    @Masterwallstreet This is one of the times I wish the Motley Fool had a "like" button on comments.

    The article's statistical validity is correct - but I personally think that RAD has room to grow and that we are in the beginning or middle of a multi-year turnaround. I agree more with the sentiments of this Foolish author: http://beta.fool.com/briannichols/2013/05/06/the-generic-shi...

  • Report this Comment On May 06, 2013, at 12:56 PM, SUPERMANSTOCKS wrote:

    These guys have yet in the last 10 o 15 years get a high passed 3.50

  • Report this Comment On May 06, 2013, at 2:36 PM, TMFGemHunter wrote:

    @masterwallstreet: I think you are too focused on the day-to-day fluctuations of the stock price. I wouldn't dispute that Rite Aid has the "possibility" of doubling or tripling, but it also has the very real possibility of going to bankruptcy court in the next few years if performance continues to slide.

    While RAD and WAG have similar levels of debt, Walgreen's EBIDTA is about four times higher than Rite Aid's. As a result, Walgreens has plenty of money to cover CapEx and interest payments. By contrast, Rite Aid has to scrimp and save when it comes to CapEx because interest payments eat up a substantial chunk of its earnings.

    Adam

  • Report this Comment On May 09, 2013, at 1:01 AM, myronpalay wrote:

    I'm a retired pharmacist who owned his own stores during the day when independents could get credit. I had four of them when I gave it up for working for the chains. I was asked by a cousin in the investment banking sector what I thought of Rite Aid. This was when the stock was 75¢. I toured 4 stores. They were pristine. The pharmacy was well stocked. The stores were empty. The shelves were full. I tried to find my favorite shampoo. No clerks. The aisles are like a corn maze at Thanksgiving. Nothing has happened in the past 4 years to make me change my mind. They need new management from the top down through the district managers. My take on Rite Aid has nothing to do with charts and graphs. The stores are empty. The parking lots are empty. The company is a Ptomkin Village.

  • Report this Comment On May 10, 2013, at 5:34 PM, lightshow0ne wrote:

    myronpalay's take is also mine. The prices in the *Corn-rows* seem to be 15 to 20 % above the competitions, too.

  • Report this Comment On May 10, 2013, at 6:46 PM, wackey2 wrote:

    Gee, kinda sounds like a short sale pro-mo, except, who would bother shorting a $2. stock ?

    Perhaps, the gross sales #'s reflect the dropping of some merchandise lines that were "loss leaders".

    I can only hope, as I own it at a cost so high that I can't handle selling it and facing my boo boo

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2410759, ~/Articles/ArticleHandler.aspx, 8/23/2014 1:26:37 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement