Is Rite Aid the Best Pharmacy Stock?

This third-place company is out in front of the aging baby boomer movement, making it one of the best growth opportunities in the healthcare space.

Jul 22, 2014 at 2:00PM

Health wellness is no longer just a fad. First, there's the rising consumption of vitamins and supplements. Second, there's the rising demand for drugs. Both of these are being driven by a rapidly aging population in the U.S. But it's not the likes of Walgreen (NASDAQ:WBA) or CVS (NYSE:CVS) that will be the biggest benefactors. Rather, it's the No. 3 player in the industry, Rite Aid (NYSE:RAD).

Rite Aid has over 4,500 stores and is the third largest pharmacy in the U.S. based on store count and revenues. It not only operates pharmacies but also offers clinical services. It extended its presence in the clinic industry earlier this year with its acquisition of RediClinic.

Capitalizing on vitamins
One of Rite Aid's biggest opportunities includes a partnership with GNC. Just this year, it extended its partnership through 2019. This is a key positive, as it's a long-term play on the rise of the health-conscious consumer. Rite Aid plans to add 300 GNC LiveWell store-in-a-stores over the next five years, in addition to the 2,200 already in Rite Aids.

Rite Aid is also remodelling many stores to the Wellness format (which includes a big store redesign and more focus on clinical services). It also has a customer loyalty program via Wellness+.

Boosting margins and long-term growth
One of the best opportunities in pharma is to capitalize on aging baby boomers. This includes not only increasing exposure to vitamins and supplements, but also generics. Both of which Rite Aid is doing.

Generic drugs are generally less expensive and have higher gross margins for pharmacies. There are also a number of key medicines that will lose their patents in 2015, driving a lot more generic medications onto the market. Earlier this year, Rite Aid extended its agreement (for five years) with its key generic drug distributor, McKesson.

Rite Aid isn't the only company looking to tap the generics market -- so are Walgreen and CVS. The three key drug distributors (distributing 80% of all drugs in the U.S. collectively) are McKesson, Cardinal, and AmerisourceBergen. Rite Aid has a new deal with McKesson, and Cardinal recently signed a 10-year deal with CVS. Meanwhile, AmerisourceBergen signed a 10-year deal with Walgreen and Alliance Boots.

CVS is less of a play on retail pharmacies, where about 50% of its revenues are derived from its pharmacy benefits management segment. However, Walgreen became a larger player in the global pharmacy market earlier this year. Its 45% ownership of Alliance Boots (and potential purchase of the remaining part of the company) gives Walgreen leverage in the generic drug market, allowing it to purchase drugs cheaper, given it's now the world's largest purchaser of generic drugs.

How shares stack up
Shares of Rite Aid trade at a P/E of 15 based on next year's earnings estimates. Walgreen trades at 18, but CVS only trades at 15.4. However, one of the most compelling metrics for Rite Aid is its P/E to growth rate (PEG) ratio, which is right at 1.0. Compare that to to CVS's 1.4 and Walgreen's 1.6. What's more is that Rite Aid has the best return on investment, coming in at 18%, while CVS and Walgreen's are right at 10%. 

Bottom line
Although it's rather underrated, Rite Aid appears to be the cheapest option in the major pharma retail industry, but it also has a number of growth opportunities. For investors looking for a solid play on the rising demand for drugs and vitamins, Rite Aid is worth a closer look.

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Marshall Hargrave has no position in any stocks mentioned. The Motley Fool recommends CVS Caremark. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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