Why Rite Aid got Hammered on Earnings!

Last Thursday, Rite Aid (NYSE: RAD  ) reported earnings that surpassed analyst expectations for its most recent quarter, but issued full-year guidance that left Mr. Market feeling uneasy. As a result of the news, shares of the world's third-largest drugstore chain fell 10.24% to close at $5.17. Although the company's stock has outperformed every market index and competitors like CVS Caremark (NYSE: CVS  ) and Walgreen (NYSE: WAG  ) year-to-date, investors are likely beginning to question whether Rite Aid shares have gone up too fast and whether lower growth expectations are a sign to sell.

Earnings were in line with estimates but nothing special
For the quarter, revenue for Rite Aid came in at $6.36 billion. This represented a 1.9% gain from the $6.24 billion the company reported for the same period a year ago and it edged past the $6.32 billion that Mr. Market expected. Despite shutting down nine locations, the company saw its revenue increase due to a 2.3% jump in comparable-store sales. This was driven by a 3.5% increase in pharmacy sales but it was negatively affected by a 0.2% decline in front-end sales.

On an earnings per share basis, the company fell right in-line with what analysts expected. During the quarter, Rite Aid posted earnings per share of $0.04, well below the $0.07 it reported last year. Even though revenue increased for the quarter, the company's bottom line was affected by three things: cost of goods sold, increased share count, and the conversion of preferred stock.

The company's cost of goods sold rose from 71% of sales last year to 71.7% this year as management found it more costly to do business. Though this difference may not seem material, it meant a change in earnings per share (after taxes) of $0.12. Along with a 7.6% increase in the number of shares outstanding and a $25.6 million hit from the conversion of preferred stock, these factors really hit the company's bottom line.

This year's not looking too great
Over the past few years, Rite Aid's performance has steadily improved, with revenue staying steady and a $2.9 billion net loss in 2009 turning into a $118.1 million gain in 2013. On a per-share basis, the company reported a gain of $0.12 in 2013. Analysts had hoped the company would do far better this year with earnings coming in at $0.24.

However, management disappointed today by reporting that Rite Aid's earnings will likely fall, probably coming in at the wide range of $0.17-$0.23. Though such a miss wouldn't be catastrophic, investors are also likely scared about management's uncertain forecast that the next quarter could force results to swing one way or the other by up to $0.06 per share.

Rite Aid falls far short of its peers
There are two words that can describe how Rite Aid has fared compared to rivals like CVS and Walgreen; poorly but encouragingly. Over the past five years, the results of Rite Aid have been terrible, with revenue at a standstill and the aggregate net loss coming in at $4.2 billion. CVS and Walgreen, however, have performed considerably better.

Looking over the past five fiscal years, we see that CVS has been an engine for growth. The company saw its revenue grow by a whopping 40.8% during the period from $87.5 billion to $123.1 billion. This makes CVS, by far, the largest drugstore chain in the world. However, the company's growth has come at the cost of consistently low margins.

For instance, the net profit margin at CVS in recent years has been downright depressing, with a five-year average of 3.5%. Though this in itself isn't terrible, when you consider that the company's margin has declined almost every year and it has fallen from 3.7% five years ago to 3.1% now, then the situation begins to look very scary. What this implies is that management believes in growing the business even if that means forgoing profitability now.

Walgreen, on the other hand, has taken a very different approach. Over the past five years, revenue at the second-largest drugstore chain in the world rose 14% from $63.3 billion to $72.2 billion. By looking at this statistic and comparing it to CVS's results, you might conclude that Walgreen has been having difficulty surviving its larger peer's growth spurt. Unfortunately for shareholders of Walgreen, this appears to be the case.

Over the past five years, the net income at Walgreen has increased by 22.1%. The disparity between revenue growth and net income growth has led the company to report a slightly higher net profit margin. While the company's five-year average net profit margin has been 3.3%, it clocked in a margin of 3.4% for its most recent fiscal year.

Foolish takeaway
As we can see, the situation at Rite Aid is far from great but it's not terrible either. Rite Aid's results have been improving and this looks set to continue in the near future. However, compared to Walgreen and especially CVS, the company comes up short on both growth and profitability. While it is possible that management can continue this turnaround and make the company consistently profitable, an investment in Rite Aid should be reserved for those willing to handle the risk of a day like Thursday. For someone more interested in the preservation of capital, a look at CVS or Walgreen might be justified.

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Read/Post Comments (5) | Recommend This Article (3)

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 December 25, 2013, at 11:44 AM, InsideRiteaid wrote:

    Rite Aid's infrastructure is getting very old. They have cut spending to the core. At some point they are going to have to spend a lot to upgrade. They are pushing everything back for profits now.

  • Report this Comment On December 25, 2013, at 12:01 PM, BuffettJr89 wrote:

    Hello InsideRiteaid! Thank you very much for reading my article! I greatly appreciate it! I would have to agree with you there. Eventually, any company that tries to do nothing but cut costs will have some problems down the road. Such a company's thought process is that when times are better, they will be able to afford those costs. However, this is akin to borrowing on a credit card with the intention of paying it off whenever you get a big pay raise you hope to see but aren't guaranteed. Whether or not Rite Aid will be able to justify forgoing these expenses now remains to be seen.

  • Report this Comment On December 25, 2013, at 1:52 PM, bluesky64 wrote:

    Danial,

    You saw it coming When the street did'nt like the SSS monthly figure. That was tell tail of what's to come add on yr end profit taking insider window opens to selling and reduced guidance and the chart. The result were clear. Now you have all the cramer and fast money trying to pump it up and the facts are still the same RAD is a great company. That turned itself around and is now stable. Time to find the next turn around

    AMD fit the ticket the score card reads the same as did RAD back in January all analyst sell and low institutional holdings and loses for months. Some thing are bearing out turn around the loses are gone the shorts are trying to cover there 130 million shorts and the analyst are moving to initiate coverage and the chart looks great. AMD products are sold out world wide and the news of there great products are second to none. Most analyst have Dec. 31 2014 price target $10.75 that's a triple just like RAD did. Merry Christmas

  • Report this Comment On December 25, 2013, at 3:15 PM, dabcom wrote:

    Rite aid future outlook,

    I have been following rite aid stock since it was in the $25.00 a share figure. The company had some accounting issues an eventually cleaned up the mess with new management. Over the years they have been rebuilding there product name with new ideas and introductions of new ways of doing business with the customers. I now believe investing in Rite Aids 4,600 plus stores is like buying a new company stock issue at a bargain price but has a very strong customer base already in place with the future potential of acquiring a great number of new customers with the aging population of baby boomers and the affordable health care program ready to go forward next year. I want to buy more shares and hold on.

  • Report this Comment On December 25, 2013, at 10:46 PM, 20eagle16 wrote:

    dabcom... I tend to agree more with you on the issue of Rite Aid. It IS like buying into a new company at a good price and with an already in-place customer base. I wouldn't have given you two cents for this company a couple of years ago. I look at the company differently now. I like what they are doing with the Wellness stores, which is why I do not see the argument above about infrastructure as being valid. I have also noticed a positive attitude change with the workers at the front of the stores and have taken the time to voice my appreciation to local management. At these stock prices, I will be a strong buyer and will continue to build up my position in RAD.

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