Has This Drugstore Chain Found a Winning Strategy?

Rite Aid (NYSE: RAD  ) has spent much of the past decade weighed down by a heavy debt load that has made competing against industry leader Walgreen (NYSE: WAG  ) very difficult.  However, the company has found momentum, not to mention better results, by positioning itself as a health and wellness outlet for customers.  According to a 2012 RAND Health study, wellness programs are the rage in corporate America, with half of surveyed companies offering wellness promotion programs.  Likely, companies are trying to keep their employee base healthy in order to promote maximum productivity.  So, can investors find value in this story?

What's the value?
Rite Aid has a solid operating position as the #3 drugstore chain, trailing only Walgreen and CVS, with over 4,600 stores around the country.  As with its competitors, Rite Aid gets most of its revenue from prescription drug sales, accounting for 68% of sales, although it does offer almost 3,000 items in general merchandise categories.  Given its front-line position in the drug distribution system, Rite Aid has rebranded itself as a health store, capable of providing a range of services including prescription management, wellness advice, and non-emergency medical treatment.

In its latest fiscal year, Rite Aid's financial turnaround made noticeable improvement.  While the company's sales were down marginally, its adjusted operating income increased 19.7% versus the prior year.  Top-line growth was negatively affected by having fewer stores in operation, as well as comparable store declines in its prescription drug sales, an area which continues to be hurt by a shift to lower-priced generic drugs.  On the upside, Rite Aid's move to a wellness format in its stores, with 800 store conversions in 2012, is allowing it to sell more higher-margin, wellness-based services, including flu immunizations that enjoyed a 60% volume increase over the prior year.

Perhaps one of Rite Aid's best moves was partnering with retail health giant GNC (NYSE: GNC  ) for store-within-a-store shops that leverage GNC's strong brand name in the vitamins and nutritional supplements area.  There are currently over 2,100 shops in Rite Aid's national network, roughly 47% of its overall store base, with plans to roll out the format to additional stores in the future.  The partnership is also a symbiotic one, creating low-cost growth opportunities for GNC.  In FY2013, the wholesale segment has been GNC's fastest growing unit, with sales up 15.2%, as well as generating the company's highest segment operating margin.

Going global
Of course, Rite Aid still has work to do to chase down industry leader Walgreen, whose operating margin of 4.8% in FY2012 was nearly double that of Rite Aid.  The company is similarly positioning itself for growth in the wellness area with a larger portfolio of in-store clinics, usually staffed by a nurse practitioner, that offer comparable services to Rite Aid, including prescription management and education.  Walgreen has also bet big on a global expansion of its operating footprint, with its 2012 multi-billion dollar acquisition of a major stake in Alliance Boots, the U.K.-based operator of over 3,000 health and wellness stores around the world.

In FY2013, Walgreen has posted mixed results, as it continues to try to win back customers that left for other pharmacies during the company's temporary spat with benefits giant Express Scripts in 2012.  For the period, Walgreen reported flat sales growth and a 7.2% decline in operating income compared to the prior-year period.  Like Rite Aid, Walgreen has been negatively affected by declining comparable store sales in the prescription drug area, down 4.2% for the period, as consumers and their payors increasingly move toward filling prescriptions with generic equivalents.  However, the company's initiatives, like its Well Experience pilot store format, should provide long-term growth opportunities as Walgreen positions itself as a trusted health advisor, rather than as just a middleman in the drug distribution network.

The bottom line
Despite a hefty debt load, which tips the scales near $6 billion, Rite Aid is on the right path with its GNC partnership and its focus on selectively trimming unprofitable stores from its network.  Given the federal health care reform's focus on employer incentives for wellness activities, the drugstore chains look well positioned for a greater role in the proactive management of its customers' health.  While it is unlikely to unseat Walgreen's for overall industry leadership, Rite Aid should be one of the industry's winners and belongs on investors' watchlists.

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  • Report this Comment On September 02, 2013, at 9:06 AM, oldfart65 wrote:

    Certainly a turnaround situation but then Peter Lynch made a lot of money on these types of stocks.

    Worse case scenario (well maybe) is that their prescription files are worth billions.

    Not an easy one.

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