3 Reasons Rite Aid Corporation's Stock Could Rise

Rite Aid Corporation's (NYSE: RAD  ) stock is on a roll. It's just not a good one.

Over the past three months, shares of the large pharmacy retailer have dropped around 28%. That's the bad news. The good news is that the stock is still up more than 20% year-to-date thanks to a fantastic run from January through early June. Could the momentum change for Rite Aid? Here are three reasons the stock could rise again -- although it's important to note that no one has a crystal ball (even if everything goes right for the company, a more general market correction could still cause shares to decline).

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1. Generics

Never underestimate the importance of generic drugs to the financial health of pharmacy chains. Rite Aid's stock decline was precipitated in part by the lack of enough generic drug savings to offset lower reimbursement rates. One key factor for this dilemma came from timing issues with the company's new purchasing arrangement with McKesson

The nice thing about timing issues is that they eventually go away. Rite Aid CEO John Standley stated in June that savings from the McKesson deal will build up in the company's fiscal second quarter, which ended in August. The extent of the positive impact won't be known until Rite Aid announces its financial results in a couple of weeks, but his confidence in the advantages from the agreement seems well-placed. 

It's also simply a matter of time for more good news on the generics front. Rite Aid's initial financial projections counted on the availability of generic Nexium earlier this year. The launch of the generic version of the blockbuster heartburn drug has been delayed, however, due to Ranbaxy Laboratory's problems winning FDA approval. Ranbaxy is scrambling to resolve the manufacturing facility issues behind the delay. If it succeeds in doing so, Rite Aid will benefit. 

2. Wellness
Wellness should help Rite Aid from several angles. First, the company's Wellness concept stores boast higher same-store sales and prescription growth than its other stores. At the end of May, Rite Aid counted 1,325 Wellness stores -- 29% of its locations. The pharmacy retailer plans to remodel 450 stores to support the Wellness model this fiscal year, which should drive more dollars to the bottom line. 

Second, Rite Aid's Wellness+ customer loyalty program has potential to pay even greater dividends. This program provides exclusive savings and wellness benefits to members. The Wellness 65+ program includes nearly 2 million seniors in its ranks. 

Third, the company should reap rewards from its big push for Americans to get flu shots. Flu season is rapidly approaching and could drive more customers to Rite Aid stores. 

Rite Aid could also be a beneficiary of a wellness decision by rival CVS Health. CVS recently removed all tobacco products from its stores -- a move that could cost the company $2 billion. Those dollars could gravitate to Rite Aid as cigarette smokers and tobacco users change their pharmacy shopping destinations. 

3. Expectations
Near-term expectations have been lowered for Rite Aid since the company announced disappointing financial results last quarter. The stock's fall reflects this reality. However, long-term expectations are still quite positive.

Thomson Financial Network polled nine analysts who cover Rite Aid. On average, these analysts project earnings growth for Rite Aid to be five times higher than the industry as a whole this year and significantly higher over the next five years as well. These growth projections give the stock a price-to-earnings-to-growth, or PEG, ratio of 0.45. That's the kind of level that would make legendary investor Peter Lynch practically drool.

Are those growth estimates reasonable? I think so. Health reform continues to be a boon for Rite Aid, particularly in states that expanded Medicaid. The aging of Americans is another macro trend that works to the pharmacy chain's favor.

The above factors could easily help Rite Aid's stock to rebound. On the other hand, they might not make a huge difference immediately.

Rite Aid's arrangement with McKesson and the anticipated launch of generic Nexium should yield benefits. The various Wellness initiatives (including CVS Health's) should prove quite helpful. But in both cases, the timing of when the positives begin to mount up is difficult to predict. And lowered near-term expectations can overrule higher long-term expectations for longer than you might think.

All that being said, our focus at The Motley Fool is on the long run. If that's your time horizon, Rite Aid could be a stock to seriously consider.

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  • Report this Comment On September 05, 2014, at 12:34 PM, hughjwade wrote:

    Nice work, Keith Speights! I enjoyed the article and thought it captured the upside of RAD. After years of management continually stabbing us in the heart, this team and this leadership is making the right moves. It is by far my biggest position. Around 2008, they were left for dead, and the only reason I didn't sell was because I didn't have much left to lose. Plus, even though they were unprofitable, they were covering their debt, their cashflow was still barely positive, so I thought they would survive. The numbers like that don't lie, nor hopefully do the key factors you have pointed out. Still a lot of "waiting to fail" CW with this stock, which is to our advantage in the long run.

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