Please ensure Javascript is enabled for purposes of website accessibility

Rite Aid Turns a Profit: Why I'm Not Impressed

By Adam Levine-Weinberg - Apr 15, 2013 at 12:30PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Rite Aid posted a surprisingly strong profit last Thursday. However, the company remains poorly positioned relative to Walgreen and CVS, and will slowly bleed market share to its larger, better capitalized rivals.

On Thursday morning, Rite Aid (RAD 10.69%) posted a fourth-quarter EPS of $0.13, which beat the average analyst estimate for a slight loss. This quarterly profit -- the second in a row for Rite Aid -- allowed the company to post its first full year of profitability since 2007. This surprisingly strong performance caused Rite Aid shares to soar nearly 30% over the course of Thursday and Friday, to highs not seen for almost five years.

RAD Chart

Rite Aid 5 Year Price Chart, data by YCharts.

Nevertheless, Rite Aid's relatively strong fiscal year 2013 results were driven by a number of one-time or short-term benefits. These items helped mask the company's fundamental competitive disadvantages vis-a-vis larger rivals Walgreen (WBA 0.90%) and CVS Caremark (CVS 0.73%). While Rite Aid could generate impressive stock returns in a best-case scenario, the company's poor competitive positioning creates substantial long-term risk for shareholders. Therefore, I still think investors would be wise to avoid the stock.

Strong results, modest outlook
Rite Aid's profit was driven by three major one-time or short-term impacts. First, the company gained a number of new customers from Walgreen's dispute with pharmacy benefits manager Express Scripts (ESRX). Walgreen's stores rejoined the Express Scripts network as of Sept. 15, and customers are beginning to trickle back, but Rite Aid still saw a significant benefit from the dispute in fiscal year 2013. On Rite Aid's Thursday morning conference call, executives estimated the full-year benefit at $70 million -- more than half of the company's fiscal year 2013 profit.

Second, Rite Aid -- as well as other pharmacy chains -- gained additional sales this quarter from a particularly bad flu season. For example, in January, Rite Aid reported a 5% increase in prescription count, with more than two-thirds of the increase attributable to flu shots and flu-related prescriptions. Last, pharmacy chains achieved higher profit margins this year due to the introduction of a number of new generic drugs, which are more profitable than brand-name drugs.  Over time, reductions in insurance reimbursement rates will negate this margin increase.

Looking forward, Rite Aid expects same-store sales, adjusted EBITDA, and net income to all be roughly flat next year. Management called attention to the loss of some Express Scripts customers who will return to Walgreen's, fewer generic introductions, and reductions in reimbursement rates as major headwinds for fiscal year 2014. If Rite Aid executives are being overly conservative with their guidance, then the stock could continue to rise. However, based on Rite Aid's fairly uninspiring March sales results, I think the guidance for flat sales and earnings next year is very appropriate.

Encroaching competitors
Longer-term, I think Rite Aid will have trouble remaining profitable in the face of strong competition from its two larger rivals. Rite Aid has benefited from trends such as the growth of generics and the aging of the U.S. population, which are helping the whole industry. For Rite Aid, improving industry conditions have allowed the company to reduce its leverage while remodeling a few hundred stores each year. By contrast, Walgreen and CVS have more resources at their disposal, and so strong profitability has encouraged expansion. In their most recent fiscal years, CVS added 131 stores, and Walgreen added 175 stores.

Convenience is paramount in the drugstore business, and as Walgreen and CVS add locations -- thereby moving closer to customers -- they will gain market share. Expansion will also increase economies of scale for both chains. Rite Aid does not have the capital resources to expand, and has actually been reducing its store count. In the short term, closing underperforming stores should boost Rite Aid's profitability, but in the longer term, this will increase the competitive advantages of Walgreen and CVS.

Buyer beware
Rite Aid's high leverage gives the stock substantial upside if management is able to enact a sustainable turnaround. However, I am not optimistic about Rite Aid's chances in an industry where its two main competitors are significantly larger and expanding, while Rite Aid is slowly shrinking. As Walgreen and CVS move closer to customers through store expansion, Rite Aid will struggle to maintain its market share. As a result, the company's return to profitability could prove short-lived.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Rite Aid Corporation Stock Quote
Rite Aid Corporation
RAD
$5.28 (10.69%) $0.51
Walgreens Boots Alliance, Inc. Stock Quote
Walgreens Boots Alliance, Inc.
WBA
$42.46 (0.90%) $0.38
Express Scripts Holding Company Stock Quote
Express Scripts Holding Company
ESRX
CVS Health Corporation Stock Quote
CVS Health Corporation
CVS
$97.15 (0.73%) $0.70

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
322%
 
S&P 500 Returns
116%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 05/26/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.