Rite Aid's Recent Remedy

Drugstore operator Rite Aid (NYSE:RAD) just closed a major acquisition that will bring it closer to matching the sales of the two largest players in the space. But is it the right prescription to make it a more formidable rival?

Right after ending its first quarter, Rite Aid closed on acquiring 1,854 Brooks and Eckerd drugstores, bringing the total store count to about 5,100. To put that into context, industry-leader CVS/Caremark (NYSE:CVS) operates just more than 6,200 stores while Walgreen (NYSE:WAG) recently weighed in with just under 5,600.

Quarterly details have less meaning as the new stores will account for the bulk of a 46% projected sales increase for the full year, but Rite Aid posted solid first-quarter sales growth as other acquisitions, low single-digit total sales expansion, and same-store sales improvements all boosted the top line.

However, CVS is also growing rapidly from its own acquisitions, and Walgreen has grown for decades by opening its own stores. Both are much more profitable, and both posted EBITDA margins that more than doubled the 3.6% Rite Aid posted over the last 12 months.

Rite Aid estimates its EBITDA margin will reach nearly 4% as it wrings out costs from the Brooks/Eckerd purchase, but the gap between it and the two titans becomes wider on a net basis. Rite Aid has a heavy debt load after years of acquisitive growth, causing interest expense to eat up a large chunk of earnings.

I recently suggested that Rite Aid has huge potential if it can come close to matching the margins of its larger rivals. Its stock has already outperformed CVS, Walgreen, and regional player Longs Drug Stores (NYSE:LDG) over the past couple of years as the market took note of its enhanced market-share clout. But as it stands currently, management estimates it will post negative earnings for the second straight year. Time will tell whether recent moves will turn Rite Aid into a more profitable operator.

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Fool contributor Ryan Fuhrmann is long shares of Walgreen but has no financial interest in any other company mentioned. Feel free to email him with feedback or to discuss any companies mentioned further. The Fool has an ironclad disclosure policy.