Rite Aid: Is Growth a Game Changer?

Rite Aid (NYSE: RAD  ) has seen a near-$650 million improvement to its bottom line over the last three years, without any top-line growth. Still, the company trades at a deep discount to its peers Walgreen (NYSE: WAG  ) and CVS Caremark (NYSE: CVS  ) , but could revenue growth be key in closing that gap?

Rite Aid: Where it has been and what's occurred
To fully understand Rite Aid's recovery, and what's driven its stock price from $1 to nearly $6, you have to understand where the company had been and what it has accomplished.

If you rewind to late 2012, many were betting on bankruptcy, as it had been years since the company had earned a quarterly profit, and it was continuously losing market share to peers CVS and Walgreen.

Furthermore, from 2009 till 2012 the company's debt-to-assets ratio increased annually, from 70% to more than 85%, meaning the company appeared more set for a death spiral than a 500% recovery.

Then, the company posted its first quarterly profit in four years, of $61.9 million, which was the spark that lit this fire. Since then, the company has posted a quarterly profit in each following earnings report, and this profit alone has driven the stock to such large gains.

How it accomplished the recovery
Rite Aid's recovery can be attributed to many things: Some will say it's the company's loyalty program, and others will say the closing, remodeling, and relocating of unprofitable stores is finally starting to pay off.

However, one reason that all agree on is the patent cliff and the introduction of new generic drugs, which is something that management for Rite Aid, Walgreen, and CVS all note as being instrumental in boosting margins.

The patent cliff is a five-year period between 2011 and 2016 in which $133 billion of branded drugs are being introduced to the market as generics via patent expirations. These generics give pharmacies more pricing power, are bought in bulk, and return higher profits per script than brand drugs.

As a result, pharmacies have surged.

What's the next step?
One fact that many often forget is that Rite Aid achieved its massive gains despite no growth.

If we look back to the three quarters that sparked gains from $1, starting Dec. 20, 2012, comparable-store sales for the pharmacy were as followed:

Fiscal Quarter

Date

Comparable-Store Sales

Third

Dec. 20, 2012

(1.5%)

Fourth

April 11, 2013

(2%)

First

June 20, 2013

(2.5%)

As you can see, comparable-store sales actually worsened during this period, but it didn't stop shares of Rite Aid from surging more than 200%. That said, take a look at Rite Aid's comparable-store sales for the last three months, via monthly reports.

Month and Year

Comparable-Store Sales

November 2013

2.8%

December 2013

2.9%

January 2014

1.8%

Clearly, Rite Aid is starting to achieve growth, something that has not been a staple in its incredible stock rally. Therefore, with the addition of growth, this could spark the next phase of gains for Rite Aid, a stock with room to run a lot higher.

Not comparable to its peers
Rite Aid's recent production of growth is not to the same level as its peers Walgreen and CVS.

In Walgreen's last quarter, it saw revenue growth of 5.9%, and like Rite Aid, it continues to see margin and net income improvements, up 68% in the same quarter. If we look to analyst expectations, Walgreen should grow another 4.8% this year.

CVS is expected to grow at the same sub-5% rate this year. Furthermore, CVS' last quarter mirrored Walgreen as well: The company grew sales by 5.8% and net income 24.7% year over year.

Therefore, CVS and Walgreen are both in better fundamental shape than Rite Aid... and are priced as such.

This fact is an important point to remember when assessing these three companies and determining upside. For example, Rite Aid trades at 19 times earnings with a profit margin of 1.2%, but if Rite Aid had CVS' margin, it would trade at about six time earnings.

This brings up the point that Rite Aid also trades at just 0.2 times sales, about one-third the valuation of its peers. Hence, Rite Aid is greatly discounted from its peers likely because it lacks the growth -- and in past years, it lacked any growth.

Room to run higher with growth
So, if Rite Aid is now growing, even if it's less than 1% annually, it stands to reason that the stock deserves a greater multiple to its peers.

Perhaps CVS and Walgreen are still worth a 100% premium to sales, based on the assumption that growth is sustainable and margins will continue to rise with new generic introductions. If so, and with Rite Aid trading at one-third to one-fourth the valuation of its peers, then shares could still increase 50%.

If the market decides that Rite Aid is worthy of the same multiple as its peers based on greater upside potential, then shares of the stock could still triple or more as the company continues to grow.

The bottom line: Rite Aid still presents a lot of upside, and with its newfound level of growth, investors should anticipate further gains should.

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