With 2014 nearly half way over, investors who purchased a stake in Rite Aid (NYSE: RAD ) at year-end can look back and pat themselves on the back. Even after shares fell 16% from their 52-week high, Rite Aid's stock is still trading 42% above the $5.06 it could be purchased for on Dec. 31. With this in mind, some investors are probably wondering if now is the time to sell and move on. But is it possible that the opportunities facing Rite Aid and its rivals CVS Caremark (NYSE: CVS ) and Walgreen (NYSE: WAG ) still leave plenty of room to run?
Generic drugs could be a boon for business
According to the IMS Institute, global spending on drugs can be expected to grow by between 21% and 24% from $965 billion in 2012 to about $1.2 trillion by 2017. If this assessment is correct, the largest growth rate will take place in the realm of generic drugs, which will soar from $261 billion in 2012 revenue to $432 billion in 2017. While any growth at all is a good thing for a business like Rite Aid, the best-case scenario is to see its exposure to generic drugs increase as much as possible.
In its most recent annual report, Rite Aid revealed that its pharmacy sales made up 67.9% of total revenue for the year, in line with what the business attributed to its pharmacy operations five years earlier. However, the retailer claimed in its reports that its revenue has been depressed by the introduction of additional generic drugs, which carry lower price points, while its margins have improved because of the lower corresponding costs.
Perhaps the only downside to investing in Rite Aid from this standpoint is that its exposure to the shift toward generic drugs will be capped by its concentration within the U.S. In aggregate, developed countries will only see their generic drug markets expand from $100 billion to $143 billion, with a lot of the global growth concentrated in emerging countries and rest of world.
During this period, rivals like CVS and Walgreen seem much more likely to benefit. With 65 stores internationally, CVS will see some of the upside; but the biggest winner is likely to be Walgreen, which currently owns 119 operations abroad and may be acquiring the 55% of Alliance Boots it doesn't already own next year.
Private brands are a big business
In an effort to improve its operations, Rite Aid began selling its own private brands during its 2011 fiscal year. The benefit of this approach is that private brands tend to result in higher margins for the business that owns them since they do not have to pay the name-brand price charged by another distributor. Since the rollout, the company has seen its private-brand sales grow to an impressive 18.2% of consolidated revenue. Because of these higher margins, Rite Aid's goal of focusing more of its efforts on these operations could prove beneficial moving forward.
This exposure is on par with CVS' initiatives as of its most recent fiscal year. According to the company's financial statements, approximately 18% of its revenue came from proprietary products during the year. Unfortunately, Walgreen does not disclose what portion of its sales come from private brands, but it has disclosed that it does engage in a business model similar to Rite Aid and CVS in this respect.
Innovation is the key to success
The final opportunity for Rite Aid I want to highlight is its ability and willingness to innovate. Right now, the drugstore chain has around 1,215 (or 26%) of its 4,587 stores set up under its Wellness store format. Of these, 405 locations were remodeled in its 2014 fiscal year, and the company expects to add another 450 to its project this year. On top of having Wellness Ambassadors to provide customers with health information, these stores sell new products and offer clinical pharmacy services to their customers.
This change in business model, combined with Rite Aid's wellness and loyalty programs, gives shareholders a lot to look forward to, but it's also important to remember the retailer's Rite Aid Health Alliance project. In an effort to increase its hold on the clinical pharmacy market further, the company announced this project, which has focused on working with health-care providers to offer care and support to customers with significant health issues. In the event that management can grow this program, it could provide a great deal of upside for Rite Aid and its shareholders.
Based on the data provided, Mr. Market is generally optimistic about Rite Aid and its prospects. Right now, it's too early to tell for certain what the future holds for the business, but with its fundamentals improving and its ability to capitalize on all these opportunities, the retailer looks poised to benefit. The only trick is whether management has what it takes to execute on these opportunities, which is something only time will tell.
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