On Thursday morning, Rite Aid (RAD +0.00%) reported another month of lackluster sales results. For March, same-store sales were down 2%, whereas top competitor Walgreen (WAG +0.00%) reported a 0.7% increase in comparable-store sales. (The third pharmacy giant, CVS Caremark (CVS +0.80%), does not report monthly sales.) Walgreen is continuing to recover strongly from last year's dispute with Express Scripts (ESRX +0.00%), and the company appears to be winning market share back from Rite Aid. As a result, I expect Rite Aid's recent return to profitability to prove short-lived.
The details
Rite Aid's sales decline last month was comprised of a 3.8% increase in front-end sales and a 4.5% decrease in pharmacy same-store sales. Much of the decline can be explained by the introduction of various new generic drugs in the past year; generics are cheaper than brand-name drugs, but carry higher margins for pharmacies. It is perhaps more meaningful to look at prescription count, which does not differentiate between brand-name and generic drugs. On that basis, Rite Aid reported a modest 0.3% increase over the prior year.
On the other hand, Rite Aid estimated that front-end comparable-store sales benefited by 300 basis points due to the calendar shift of Easter into March. Stripping out all of the moving parts, it appears that Rite Aid's core sales growth is less than 1%, well below the pace seen for much of the last year.
Competition heats up
Much of Rite Aid's improved performance last year was a direct result of the commercial dispute between Walgreen and Express Scripts, which forced Express Scripts customers to fill their prescriptions elsewhere. While it is difficult to quantify the benefit seen by Rite Aid (and other Walgreen competitors), Rite Aid's management has admitted that pharmacy sales were boosted by the dispute last year. However, as of Sept. 15, 2012, Walgreen's stores began to accept Express Scripts prescriptions again, and the company has a made a strong push since then to regain lost customers.
Whereas Rite Aid's prescription count in comparable stores increased by just 0.3% last month, Walgreen's stores saw a 4% increase. Walgreen's management also commented that "the percentage of former Express Scripts customers returning to its pharmacies continued to increase in March."
Looking forward
Going forward, Rite Aid will continue to be squeezed by its two larger competitors, Walgreen and CVS. Now that Express Scripts customers are starting to return to Walgreen's stores, Rite Aid is experiencing anemic sales growth. Furthermore, Walgreen and CVS are both expanding, while Rite Aid is gradually shrinking its store base. This trend will give Rite Aid's competitors even more economies of scale, while new CVS and Walgreen's stores will likely target current Rite Aid customers.
Rite Aid stock is too speculative to recommend for most investors at this point in time. While Rite Aid's enterprise value of $8 billion is significantly below that of Walgreen ($49 billion) the lower valuation is fully justified by the company's weak profitability. Rite Aid continues to face significant long-term challenges, and I am skeptical that last year's upturn was anything more than a one-time bounce attributable to the Walgreen-Express Scripts dispute. With Express Scripts customers now returning to Walgreen's stores, Rite Aid will probably resume its slow decline.
