CVS Caremark Vs. Rite Aid: Has Rite Aid Been Overbought?

Source: Wikimedia Commons

After news broke that Credit Suisse was reiterating an outperform recommendation on shares of Rite Aid (NYSE: RAD  ) with an expected price target of $8.50, shares of the country's third-largest drugstore chain popped up nearly 5%. With Rite Aid's shares trading at $8.12, 210% above their 52-week low of $2.62, is now actually a time to be selling and buying rivals like Walgreen (NYSE: WAG  ) or CVS Caremark (NYSE: CVS  ) ? Or is there still room to run on this turnaround story?

Source: Rite Aid

Mr. Market has high expectations for Rite Aid!
Over the past few years, Rite Aid has been something of a mixed bag. Between 2009 and 2013, the company's revenue fell almost 1% from $25.67 billion to $25.53 billion; a wave of store closures has been, more or less, canceled out by improving comparable-store sales.

At first glance, this performance may just seem mediocre instead of terrible. But when you consider that Walgreen's revenue has risen 14% from $63.3 billion to $72.2 billion during its most recent five-year period, Rite Aid suddenly looks bad. CVS' metrics have come in even better. Over the past five years, the company's sales have popped up 29% from $98.2 billion to approximately $126.8 billion.

RAD Revenue (Annual) Chart

Rite Aid revenue (annual) data by YCharts

From a revenue perspective, Rite Aid can't even come close to matching its peers. However, it's not sales that have shareholders excited; it's the company's rise in profits. While revenue for the retailer has decreased a bit, management's cost-cutting initiatives have pushed the company's net loss of $506.7 million to a gain of $249.4 million. This improvement in profitability has been due, in part, to lower interest expenses and impairment charges but has also stemmed from declines in the company's core costs in relation to sales.

During its five most recent fiscal years, Walgreen's net income has also risen to the tune of 22% from approximately $2 billion to $2.4 billion. At almost double the pace of the company's revenue jump, this may seem appealing. However, when you consider that the largest contributor to the business' higher profits in 2013 came from an investment in Alliance Boots as opposed to an improved operating margin, its performance isn't as impressive. Over this time frame, CVS' net income increased 24% from $3.7 billion to about $4.6 billion as higher sales were offset by marginally higher costs.

Rite Aid's getting better, but is it cheap enough?
In its report, Credit Suisse said that it expects the company's results to be somewhat choppy in the near term but that growth should start taking off in 2015 and 2016. This, combined with Rite Aid's return to profitability, could signal a brighter future for the company. But is it possible that investors getting in now are paying too much for the company?

Using its most recent year's earnings per share of $0.23, shares of Rite Aid are current trading at a price/earnings (P/E) ratio of 35. Assuming that analysts are accurate and the business earns $0.39 per share this year, then investors are still paying a hefty 21 times earnings for shares in the drugstore chain.

(P/E Ratio) 2013's EPS 2014's Forecast EPS
Rite Aid 35 21
Walgreen 27 20
CVS Caremark 21 17

Source: Yahoo! Finance

Right now, Rite Aid's valuation is richer than either of its larger rivals. Using 2013's earnings, shares of CVS can be bought for about 21 times earnings, while Walgreen comes in a little pricier at 27 times. Looking instead at analysts estimates for 2014, CVS can be purchased for 17 times earnings, while Walgreen is just a tad more expensive at 20 times.

Foolish takeaway
Despite its rather bumpy history, Rite Aid seems to be slowly digging itself out from the rut it's found itself in. While this has come at the cost of lower sales, management made the right choice by focusing on reducing costs and turning out a profit.

Once the company begins to grow again, the potential for its shareholders could be explosive. But the fact that shares are still trading at a premium to Walgreen and especially CVS should remind investors that an investment in the business isn't necessarily a slam dunk. In fact, for investors looking for something cheaper, now may be the time to consider taking money off the table from Rite Aid and allocating it to Walgreen or CVS.

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

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 30, 2014, at 10:54 AM, Magila wrote:

    Your argument would make sense if PE ratio was the only way to evaluate a stock. On the other hand if you are trying to guage the room for improvement in the stock you should look at price to sales ratio, which is a better indicator of RAD's profits once management fixes it's problems. RAD's price to sales ratio is about one fourth of Walgrees and CVS so if we assume that management can do the things we all learned in Retailing 101, Rite Aid can rise another 200% before it is valued as highly as WAG and CVS on the basis of sales.

  • Report this Comment On May 30, 2014, at 4:49 PM, JoeDee wrote:

    I agree 100% with Magila's comment. Brian Nichols is the only Motley Fool Writer who has Rite Aid figured out properly. I wish we could hear from him again soon. He predicted this performance when other's still had it priced to go out of business.

  • Report this Comment On May 30, 2014, at 7:07 PM, TURK3795 wrote:

    Ditto on the agreement with Maglia: Rite Aid began its turnaround with the release from the high interest bearing debt is was saddled with. Once their debt was restructured, their profitability began to rise. Then, coupled with generic price increases, improved marketing with various business partners, the selective closing of poor performing stores, the turnaround became inevitable.

    Now, coupled with 10,000 seniors retiring every day, smart marketing approaches for customer attraction and retention, etc., Rite Aid shares will only continue to increase based upon its own increased metrics and because it looks better and better as a take over target....

  • Report this Comment On June 03, 2014, at 7:33 PM, ang1 wrote:

    Other than Mr. Nichols, I am SO glad I didn't listen to the countless Fools who pontificated AGAINST RAD. That list of wrong Fools also includes Cramer. Oh BTW Cramer now loves RAD! Hint: The idea Fools is to try and predict how a stock may recover and join before it does so. Seems like the "experts" Monday morning quarterback and get paid big money to do so. I assume 1st graders can do that too. 100,000 shares at $1.01 and holding!! Thanks for nothing Cramer and Fools...(except you Mr. Nichols)

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